Venture Capitalists, Asymmetric Information and Ownership in the Innovation Process

Fabrizi, Simona and Lippert, Steffen and Norback, Pehr-Johan and Persson, Lars (2007): Venture Capitalists, Asymmetric Information and Ownership in the Innovation Process.

Abstract

This paper constructs a model where entrepreneurial innovations are sold into oligopolistic industries and where adverse selection problems between entrepreneurs, venture capitalists and incumbents are present. We first show that aggressive development of a basic innovation by better informed venture-backed firms is used as a signaling device to enhance the sale price of the innovation. We then show that incumbents can undertake early, preemptive, acquisitions to prevent such signaling driven overinvestment, despite the risk of buying a non-productive innovation. Therefore, to exist in equilibrium, venture capitalists must be sufficiently more efficient in selecting innovation projects, otherwise preemptive acquisitions will take place.

• Item Type: MPRA Paper
• Language: English
• Keywords: venture-backed firm, innovation, signaling, overinvestment, interim development, M&A
• Subjects: D - Microeconomics > D2 - Production and Organizations > D21 - Firm Behavior: Theory; L - Industrial Organization > L2 - Firm Objectives, Organization, and Behavior; C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; M - Business Administration and Business Economics ; Marketing ; Accounting ; Personnel Economics > M1 - Business Administration > M13 - New Firms ; Startups; G - Financial Economics > G2 - Financial Institutions and Services > G24 - Investment Banking ; Venture Capital ; Brokerage ; Ratings and Ratings Agencies; O - Economic Development, Innovation, Technological Change, and Growth > O3 - Innovation ; Research and Development ; Technological Change ; Intellectual Property Rights