The Excessive Creation of Sequel Firms

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• Pierre Mella-Barral, Professor - Speciality: Finance, EDHEC Business School
• Thursday 05 February 2015, 13:00-14:00
• 10 Trumpington Street.

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When an inventing firm does not exploit itself, but sells an innovation, it internalizes the value of exploiting this innovation in a newly created firm. Such a sequel firm has however the ability to contract separately. As the research production of a firm suffers from a moral hazard in team problem, it is then worthwhile for the sequel firm to build its’ own research team, in order to compete for further innovations. So selling an innovation, the innovating firm also looses some likelihood of making future innovations. This imposes a negative externality on the innovating firm. We construct a model which captures this trade-off and the resulting dynamics of sequel firm creation. We compare the equilibrium frequency of firm creation with the first-best. There is predominantly ``excessive” creation of firms, particularly in young industries. Inefficiencies fade away as the industry develops. This helps explaining the empirical observation that the frequency of sequel firm creation, as well as the focus of firms, decrease with the age of the industry.

This talk is part of the Cambridge Finance Workshop Series series.

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