Dynamic Competition, Innovation and Strategic Financing

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Abstract
This paper models the interactions among product market innovation, product market competition, and corporate financing decisions in the context of a dynamic duopoly. One competitor faces an opportunity to adopt a new technology. If adopted, the firm must also determine whether it will obtain public or private financing. Our results allow us to relate current firm and industry characteristics to these decision variables. In particular, larger, more profitable firms with small rivals have the greatest incentives to innovate. The private versus public financing decision depends mainly on the magnitude of the technological improvement and length of the period during which private financing extends the innovator’s product market advantage. Due to the model’s formulation it is both tractable and amenable to empirical estimation. We estimate the model and provide estimates of the value of innovation and private financing for a sample of industries and firms.

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