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Journal Article

The Financing of Innovation: Learning and Stopping

Dirk Bergemann and Ulrich Hege
The RAND Journal of Economics
Vol. 36, No. 4 (Winter, 2005), pp. 719-752
Published by: Wiley on behalf of RAND Corporation
Stable URL: http://www.jstor.org/stable/4135254
Page Count: 34
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The Financing of Innovation: Learning and Stopping
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Abstract

We consider the financing of a research project under uncertainty about the time of completion and the probability of eventual success. We distinguish between two financing modes, namely relationship financing, where the allocation decision of the entrepreneur is observable, and arm's-length financing, where it is unobservable. We find that equilibrium funding stops altogether too early relative to the efficient stopping time in both financing modes. The rate at which funding is released becomes tighter over time under relationship financing, and looser under arm's-length financing. The tradeoff in the choice of financing modes is between lack of commitment with relationship financing and information rents with arm's-length financing.

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