Innovation, competition, and investment timing

Abstract

In our model multiple innovators compete against each other by submitting investment proposals to an investor. The investor chooses the least expensive proposal and when to invest in it. Innovators have to provide costly effort and they learn privately the cost of investing. Innovators’ effort costs have to be compensated for, but on the positive side competition helps to erode innovators’ informational rents, since innovators are more likely to lose the competition if they inflate investment costs. Consequently, competition leads to faster innovation, because the investor has less need to delay expensive investments. The investor’s payoff sensitivity also increases with competition, thus enabling the investor to capture more of the upside of innovative activity.