Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/22943 
Year of Publication: 
2005
Series/Report no.: 
Bonn Econ Discussion Papers No. 37/2005
Publisher: 
University of Bonn, Bonn Graduate School of Economics (BGSE), Bonn
Abstract: 
We analyze innovation race in a moral hazard setting. We develop a model in which two competing entrepreneurs work independently on the same project. The entrepreneurs do not possess any wealth of their own and their research is financed by a venture capitalist. The project, if successful, generates a prize, which is to be shared between the winning entrepreneur and the venture capitalist. The venture capitalist cannot observe the allocation of funds he provides, which creates a moral hazard problem. We compare a competitive setting with a benchmark case where the venture capitalist finances only one entrepreneur. We show that the venture capitalist can increase the efficiency of research (hence, his own expected profit from investments) and alleviate the moral hazard problem if he finances both entrepreneurs. This conclusion is unambiguous, when the entrepreneurs are at the same (the last) stage of R&D. It holds for a reasonably large range of parameters, when the entrepreneurs are at different stages of R&D.
Subjects: 
venture capital
moral hazard
optimal contract
innovation race
JEL: 
G32
G34
O31
Document Type: 
Working Paper

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