Spillover and R&D Incentives under Incomplete Information in a Duopoly Industry

Spillover of R&D results in oligopolistic industries may affect the R&D decisions of firms. How much a newly eveloped technology by a firm gets spilled over to its rival firms may or may not be observable by the concerned firm. This paper considers a two stage game involving two firms. In the first stage the firms decide whether to invest in R&D and in the next stage they compete in a Cournot duopoly market. The R&D incentives of firms are compared under alternative assumptions of complete and incomplete information scenarios involving general distribution function of types. The results indicate that the impact of availability of more information regarding rival’s ability to benefit from spilled over knowledge on R&D activities of firms is ambiguous

MANAGING INNOVATIONS: INFORMATION AND CONTRACTS

Innovation has been acknowledged by both researchers and practitioners as a vital tool to yield growth and maintain competitive advantages. However, firms face stiff challenges in managing innovations. Developing new product generally requires substantial resource input, but the success rate is usually low due to internal technical difficulties and external market uncertainties. Even with successful innovative products, it is not guaranteed that the innovators will be rewarded for their efforts and investments, as the return from innovations may be siphoned off by suppliers, customers, and competitors. To profit from innovations, firms need to first create value with the right R&D strategies, and further capture value in the execution of innovations when dealing with the relevant partners. This dissertation studies the management of innovations and addresses these two important issues respectively. In the first essay, we investigate how strategically managing information can improve the new product performances in competitive R&D markets. The new product development process is essentially a series of inter-linked information processing activities: firms generate ideas, gather information from external environment to evaluate the feasibility and potential of the ideas, conduct research to create new knowledge and intellectual property, and finally commercialize the new knowledge into the market to generate value. We focus on how firms should acquire and manage external market information in competitive R&D markets, and how the information acquisition and management strategies impact their R&D investment decisions. The second essay studies how firms should manage the relationship with the relevant parties in the execution of innovations. The intrinsic uncertainty in the materialization of innovations, the intangibility of technical knowledge assets, and the difficulty of specifying and monitoring the performance of the other party, are the primary clauses that give rise to the hold-up problem in innovation partnerships -- that is, the R&D investment by a firm leaves it vulnerable to ex post opportunistic behaviors by its contracting partner (whether its supplier, customer, or joint venture partner). We study how the operational aspect of an evolving relationship may influence a firm's innate incentives to take advantage and `hold-up' the partner and mitigate the hold-up problem in innovation partnerships. The third essay extends the discussion of hold-up problem to general incomplete contracts and moral Darwinism. In conventional economic models, rational players are usually assumed to be self-interested and can take opportunistic actions to maximize their own payoffs, while socially desirable traits such as honesty and trust are often characterized as irrational and studied as deviations from tenets of rationality. However, these irrational traits are commonly observed in practice despite the widespread nature of incomplete contracts which have plenty of room for opportunism. This essay asks why traits such as honesty have not been weeded out by economic Darwinism, and offers a justification that the choice of honesty emerges both as desirable and rational under very reasonable conditions

HETEROGENEOUS AGENTS AND SPILLOVERS IN INNOVATION PROCESSES

This work is a collection of papers on innovation, a broad theme that covers several but interconnected issues. Innovation is one of the main determinants of firms\u2019 performance in advanced economies and it is also an important driver of growth ((Romer 1990, Aghion and Howitt 1992, Acemoglu 2002, Jones 2002). Firms often invest huge amounts of resources in R&D to improve their production technology (process innovation, aiming to a cost reduction), create new products and increase the quality of the existing ones (product innovation); in this way, firms aim to increase their market shares and profits. Sometimes R&D investment is necessary to enter the market or simply not to exit. Firms\u2019 innovative activities contribute to make the surrounding economic system more competitive and stimulate further investment and innovation. At the same time,consumers enjoy the benefits accrued by lower prices, better quality and more variety. Despite of the beneficial effects they bring to the society, innovative activities are often associated with a non competitive market structure (harmful for consumers) and with externalities, meaning that innovation is strictly related to situations that bring to market failures and to not socially desirable outcomes (in terms of prices, quantities produced and R&D effort). These considerations often justify the request of government intervention in terms of subsidies to R&D and patent protection. The level of innovation of an economic system is affected by the interaction of several agents and also influenced by external factors. Understanding how the different forces at work interact and which factors enhance or prevent innovation is of primary importance from the point of view of policy makers; aware of the possible incentives and obstacles to innovation, they can develop policies aimed to create an environment that favor investment and growth. In this work I investigate the role of agents\u2019 heterogeneity in innovation processes, an issue that has received attention in the literature on innovation only quite recently, tough its importance has been recognized for a long time. I treat this topic from both a theoretical and empirical point of view, though applied to different subjects. In the theoretical part of the work (Chapter 2 and Chapter 3), I focus on a particular aspect of the issues related to innovation and market failure, namely the spillover externality problem and the use of R&D cooperation agreements (RJV) as a way to enhance innovation and lead the level of investment closer to its socially optimal level. The positive externality is caused by non-complete appropriability of the results of R&D activity and is responsible for R&D underinvestment. Since d\u2019Aspremont and Jacquemin (1988) and Kamien et al. (1992), the positive effect of R&D cooperation agreements in presence of high spillovers has been widely analyzed. However, most of the previous works only consider symmetric firms, discarding the potential relevant impact of asymmetries on firms\u2019 decisions. The empirical literature has emphasized the role of asymmetries in terms of gains from cooperation, that in turn affect decisions about RJV membership (Kogut 1991, R\uf6ller, Tombak and Siebert 1998), but these issues have been scarcely taken into account in the theoretical literature, with few exceptions (Baerenss 1999, Atallah 2005). So, in this part of the work I try to fill this gap in the literature taking into account firms\u2019 heterogeneity. Firms can be heterogenous in many respects: efficiency level, type of technology, experience, market size etc. Here, firms\u2019 heterogeneity regards the efficiency of R&D effort. In the empirical part, I study a quite different aspect of innovation, namely the link between immigration and innovation. Owing to the size that the phenomenon of immigration has assumed in the advanced countries in the last decades, immigration has been recently at the centre of the political and economic debate. Economists have studied extensively the potential impact of immigration on a variety of economic and social indicators of host countries, such as natives\u2019 wages (Borjas 2003; 2005, Ottaviano and Peri 2012) and employment opportunities (Pischke and Velling 1997, Card 2001; 2005), firm productivity (Peri 2012), trade creation (Gould 1994, Rauch and Trinidade 2002, Peri and Requena-Silvente 2010) and crime (Bell et al. 2010, Bianchi et al. 2012), just to take a few examples. Until very recently the effect of immigration on innovation and technical change was instead much less studied. Although new evidence is progressively accumulating, it remains nonetheless mostly limited to the impact of skilled immigration in the U.S (Hunt and Gauthier-Loiselle 2010, Stuen et al. 2012, Lewis 2011, Peri 2012).Immigration can affect local innovation in several ways. First of all, immigration entails an inflow of foreign population into a region, and produces changes (i) in the size of the population; (ii) in the average skill level of the population; (iii) in the age structure of the population. All these variables have been recognized to be powerful predictor of innovation. Immigration has also a direct effect on innovation through cultural diversity (spillovers may arise from complementary abilities and different backgrounds, with a positive effect in the production of new ideas). At the same time, greater difficulties in communication and reduction of social capital can act as obstacles to innovation and growth (these negative effects are more likely to arise in presence of low skilled immigrants). Finally, immigrants flows affect firms\u2019 choices concerning technology adoption and investment in physical capital, according to the change in the average skill level they cause in the population. So, in this part of the work, heterogeneity concerns the greater cultural \u2018diversity\u2019and the changes in the average skill level of the population induced by large immigration flows. The thesis has the following structure: Chapeter 1 provides an overview of the way in which the main issues related to innovative activity have been treated in the theoretical literature. Starting from earlier works on innovation, mainly focused on the value attached to innovation in monopolistic and competitive markets, it develops analising the two main fields in the literature on innovation: patent race and spillover externality. The part related to spillovers and R&D cooperation is treated in a more extensive way, since the theoretical models I present in Chapter 2 and Chapter 3 belong to this strand of the literature. This chapter contains also a review of the past literature on incomplete information in R&D models. In Chapter 2, I extend standard models on R&D competition vs R&D cooperation in a context of non-complete appropriability of the results of R&D activity. In a Cournot duopoly model with R&D investment stage and spillovers, I introduce asymmetries in R&D productivity between firms that may engage in R&D cooperation. Also, with the introduction of a further stage, I analyze the incentive to cooperate in R&D by forming a RJV. While the existent literature focuses on the comparison between two scenarios exogenously given, I endogenize the formation process and show that, when spillovers are high, due to firms\u2019 asymmetries, RJV is not formed for most of the parameters\u2019 values and does not fulfill the aim of stimulating innovation. This contributes to explain the relatively low diffusion of cooperative agreement in R&D and supports some empirical findings about and the determinants of RJVs formation. Also, in line with the theoretical literature, I find that, when spillovers are low, R&D cooperation reduces the total level of investment; in this case allowing this kind of agreements can be harmful, since in some regions of parameters both symmetric and asymmetric firms have incentive to cooperate in order to avoid investment. Chapter 3 presents a further extension of the model discussed in Chapter 2, namely the introduction of the incomplete information assumption. Here, I investigate the role of R&D cooperation agreements (RJVs) in a context of incomplete information with asymmetric firms, where firms, in addition to set the optimal R&D investment under two regimes (R&D competition and RJV), have also to take decisions about RJV membership. Some interesting results arise from this extended model. (i) When firms compete in R&D, incomplete information about rival\u2019s R&D productivity leads to inefficient investment choices in some regions of parameters; in particular, when firms are actually symmetric, asymmetric information further reduces the investment, with respect to the complete information setting. (ii) A signaling role of cooperation agreements emerges, in addition to the already recognized role in reducing the inefficiencies arising from free riding problem. Revealing its willingness to participate, the efficient firm to signal its type, thus increasing the investment level (innovation enhancing effect) and improving total welfare. (iii) When firms are asymmetric, for most of the parameters\u2019 values, RJV is not formed and does not fulfill the role of stimulating innovation. Chapter 4 (joint with Massimiliano Bratti1) investigates the causal effect of foreign immigration on innovation (patents\u2019 applications) in Italian provinces. We provide evidence for a country which was exposed to a very fast and large wave of immigrations during the 2000s, using a very small geographical scale of analysis (NUTS-3 regions), which enables us to better control for differences in institutional and socio-economic factors which are difficult to observe but which may simultaneously contribute to both attracting new immigrants and increase the innovation potential of a region. Moreover, unlike most papers in the literature which only considered the effect of skilled immigration, (i) we first focus on the general impact of immigration, and then (ii) separately look at the effects of low-educated and high-educated immigrants on innovation. Using instrumental variables\u2019 estimation (and instruments based on immigrant enclaves), we find that the overall stock of immigrants has a significant negative effect on innovation of Italian provinces: rising the share of immigrants by one percent point (p.p.) decreases patenting by 0.064 percent. However, distinguishing the effect between low and highskilled migrants shows that the aggregate negative effect is driven by the prevalence in Italy of low-educated immigrants. In fact, our estimates suggest that an increase of 1 p.p. in the share of low skilled foreign migrants on the population induces a reduction in patents\u2019 applications per 1000 inhabitants in a range between 0.094 and 0.186 percent, according to the method used to classify immigrants by skill level. Instead, presumably due to the extremely low presence of high skilled immigrants in Italy and to the underutilization of their competencies, the impact of high skilled immigrants on innovation is positive, but cannot be precisely estimated

Firms, international money and prices: a survey of the literature

Sluggish price adjustments with respect to exchange rate shocks take essentially two forms. Firstly, prices do not adjust completely to neutralize the effects of nominal exchange rate shocks. Secondly, price adjustments after exchange rate shocks only take place in discrete time intervals, in other words they are discontinuous. These two features of price adjustments form our definition of international price rigidities. In this paper we shall present a survey of the empirical and theoretical literature on international price rigidities. We provide the underlying intuition of the theoretical research and present a brief summary of the empirical findings

Asymmetric multistage models of R&D : technology adoption, contracts and protection

This thesis consists of three individual models on technology adoption, contracts and protection. The first model is motivated by the inconsistency between empirical results and theoretical models regarding the firm size effects upon the timing of adoption. By proposing a two-stage, endogenous learning, Stackelberg model, we conclude that in a pure strategy equilibrium, the large firm may or may not tacitly delay its adoption to capture the information advantage, depending on cost and belief parameters. The welfare analysis provides a justification for government interventions in firms’ adoption decisions. The second model is motivated by the fact that although more and more resources have been devoted to R&D activities, there is little theoretical discussion regarding R&D funding issues. Chapter 3 derives the optimal funding contract, which happens to be a cost-plus-fixed-fee contract in the literature. After considering the adverse selection problem, the optimal contract induces no efficiency loss under both discrete and continuous settings and the principal will be more conservative in funding. The optimal auction maintains both allocation and production efficiency, and bidding the principal’s reservation price will be a dominant strategy in a second price auction. Neither the revenue equivalence nor the separation property will hold. With symmetric beliefs, the optimal funding length is shorter than that of contractible effort. Under some assumptions, the lock-in effect persists and the principal will prefer short-term contracts to long-term contracts. The third model decides the optimal protection forms, protection rates and protection lengths under various cost and revenue circumstances. Since the incentive scheme will be affected by the target firm’s future profits, we show that in the context of incomplete information, screening protection schemes can sometimes coincide with the efficient schemes. In R&D area, our result suggests that optimal patent length need not necessarily be increasing in firm’s investment efficiency

Risk management in electricity markets: hedging and market incompleteness.

The high volatility of electricity markets gives producers and retailers an incentive to hedge their exposure to electricity prices by buying and selling derivatives. This paper studies how welfare and investment incentives are affected when markets for derivatives are introduced, and to what extent this depends on market completeness. We develop an equilibrium model of the electricity market with riskaverse firms and a set of traded financial products, more specifically: forwards and an increasing number of options. Using this model, we first show that aggregate welfare in the market increases with the number of derivatives offered. If firms are concerned with large negative shocks to their profitability due to liquidity constraints, option markets are particularly attractive from a welfare point of view. Secondly, we demonstrate that increasing the number of derivatives improves investment decisions of small firms (especially when firms are risk-averse), because the additional financial markets signal to firms how they can reduce the overall sector risk. Also the information content of prices increases: the quality of investment decisions based on risk-free probabilities, inferred from market prices, improves as markets become more complete Finally, we show that government intervention may be needed, because private investors may not have the right incentives to create the optimal number of markets.

Risk management in electricity markets: hedging and market incompleteness

The high volatility of electricity markets gives producers and retailers an incentive to hedge their exposure to electricity prices by buying and selling derivatives. This paper studies how welfare and investment incentives are affected when markets for derivatives are introduced, and to what extent this depends on market completeness. We develop an equilibrium model of the electricity market with risk-averse firms and a set of traded financial products, more specifically: forwards and an increasing number of options. Using this model, we first show that aggregate welfare in the market increases with the number of derivatives offered. If firms are concerned with large negative shocks to their profitability due to liquidity constraints, option markets are particularly attractive from a welfare point of view. Secondly, we demonstrate that increasing the number of derivatives improves investment decisions of small firms (especially when firms are risk-averse), because the additional financial markets signal to firms how they can reduce the overall sector risk. Also the information content of prices increases: the quality of investment decisions based on risk-free probabilities, inferred from market prices, improves as markets become more complete Finally, we show that government intervention may be needed, because private investors may not have the right incentives to create the optimal number of markets.

Asymptotic Efficiency in Stackelberg Markets with Incomplete Information

This paper examines the asymptotic (in)efficiency of Stackelberg markets with incomplete information. Firms who are early in the queue make their quantity choices based on limited information and their output choices are likely to deviate from those optimal under complete information. Due to the presence of both payoff externality and information externality, the output deviations of early firms have a lasting effect on all subsequent output decisions. Consequently, the total market output diverges from the competitive equilibrium output even as the number of firms goes to infinity. That is, Stackelberg markets with incomplete information are asymptotically inefficient with probability one. ZUSAMMENFASSUNG - (Asymptotische Effizienz in Stackelberg-Märkten mit unvollständiger Information) In diesem Beitrag wird die asymptotische (In-)Effizienz von Stackelberg-Märkten mit unvollständiger Information untersucht. Unternehmen, die frühzeitig auf den Markt kommen, bestimmen ihre Ausbringungsmengen unter unvollständiger Information. Aus diesem Grunde sind ihre Mengenentscheidungen im allgemeinen verschieden von den optimalen Ausbringungsmengen unter vollständiger Information. Auszahlungswirksame Externalitäten und Informationsexternalitäten bewirken, daß die Mengenentscheidungen der frühzeitig auf den Markt treffenden Unternehmen zu pfadabhängigen Mengen -entscheidungen nachfolgender Unternehmen führen. Im Ergebnis ist dann die gesamte Ausbringungsmenge aller Unternehmen verschieden von dem Konkurrenzgleichgewicht - selbst dann, wenn die Anzahl der Unternehmen gegen unendlich strebt. Das heißt, Stackelberg- Märkte mit unvollständiger Information sind asymptotisch ineffizient mit der Wahrscheinlichkeit eins.