Job Market Paper
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My job market research consists of two papers: How Start-up Firms Innovate, which is a strategy and business economics paper, and a companion paper Venture Capitalists as Vendors of Complementary Components, which is a business economics and corporate finance paper. Comparative statics on the model in Venture Capitalists as Vendors of Complementary Components provide the basis for the empirical tests carried out in How Start-up Firms Innovate.
How Start-up Firms Innovate, proposes a `system vs. components' theory of innovation to understand the relationship between inventive activity and commercialization investment choices for patent-holding high-technology start-up firms. I test the theory using cross-sectional analyses and a difference-in-difference analysis on near-population data of patent-holding start-up firms that secured either an initial public offering or an acquisition between 1986 and 2004. The theory requires that entrepreneurs maximize their expected profits given both the available technological opportunity and the state of technology in their industry. Start-up firms should specialize to pit their strengths against incumbents' weaknesses or generalize to best incumbents on every dimension. Moreover, policy that affects commercialization investment choices should also affect research and development choices, and vice versa. I show that following the introduction of the 2002 Sarbanes-Oxley Act, which raised the costs of an initial public offering, start-up firms preferred to specialize in component-based invention rather than developing competitive systems.
Venture Capitalists as Vendors of Complementary Components presents a two-stage, complete information, economic model of start-up innovation. The model places a structure on the nature of technological innovation by assuming that high-technology products are made up of systems of complementary components. It then uses this structure to understand the technological differences between successful venture-capital-backed start-up firms that achieve either an initial public offering (IPO) or an acquisition. The model suggests that venture-capital-backed start-up firms that get acquired by incumbents are purchased because they specialized in creating a high-quality component that has a complementarity with the incumbent's other components. This complementarity reduces the cost of production for the incumbent and is welfare improving for consumers. The model also suggests that firms that will secure IPOs should follow a general technology strategy and internalize the complementarities between components by creating an entire rival system of components. IPOs enhance welfare by increasing competition in product markets. Whether a venture-capital-backed start-up firm should elect to pursue an acquisitions or an IPO depends on the available technological opportunity and the relative state of technologies in their innovative ecosystem. Therefore, acquisitions and IPOs are alternative profit-maximizing strategies, and both enhance consumer welfare.
Job Market paper:
- Egan, Edward J. (2013), How Start-up Firms Innovate: Technology Strategy, Commercialization Strategy, and their Relationship, Job Market Paper (pdf) (record)
- Egan, Edward J. (2013), Model Appendix to 'How Start-up Firms Innovate: Technology Strategy, Commercialization Strategy, and their Relationship' (pdf) (record)
- Egan, Edward J. (2013), Venture Capitalists as Vendors of Complementary Components, Job Market Companion Paper
Note: Until Venture Capitalists as Vendors of Complementary Components is released, its model is included in the Model Appendix to 'How Start-up Firms Innovate'.
How Start-up Firms Innovate:
A successful start-up firm makes two important strategic innovation choices during its early life. It must decide upon a 'technology strategy' -- whether to specialize or generalize in the allocation of its research and development efforts -- and a 'commercialization strategy' -- whether to cooperate or compete with incumbents to secure the investment it will need to commercialize its inventions. In this paper, I advance a `system vs. components' theory of innovation, which supposes that technological products are based on systems of complementary components. A pattern of specialize-and-cooperate and generalize-and-compete then occurs naturally as entrepreneurs maximize their expected profits given both the available technological opportunity and the state of technology in their industry. I derive measures of technology strategy for patent-holding start-up firms, and use the choice to sell the firm in an acquisition or to raise investment through an initial public offering (IPO) as prototypical examples of cooperate versus compete commercialization strategies. I then show that measures of technology strategy Granger-cause commercialization strategies in cross sectional analyses. I also address the endogeneity issue that arises because forward-looking start-up firms chose their technology strategy in anticipation of their commercialization strategy by using the introduction of the 2002 Sarbanes-Oxley Act (SOX) as a shock to the relative costs of an IPO. I provide evidence that successful start-up firms altered their technology strategies to favor component specialization following the introduction of SOX.
Venture Capitalists as Vendors of Complementary Components:
Venture capitalists obtain most of their earnings by selling or 'exiting' their ownership positions in successful start-up firms through either initial public offerings (IPOs) or third party acquisitions. The paper seeks to explain the choice between IPOs and acquisitions as exit vehicles. This paper provides a model where acquisitions of venture-capital-backed start-up firms occur because of complementarities between a start-up firm's innovations and the technology of potential acquirers. The complementarities reduce the cost of production for an acquiring incumbent and improve welfare for consumers. Initial public offerings, on the other hand, occur when a start-up firm creates an entire system of components and internalizes the complementarities between them. Entry into the product market after an IPO also increases consumer welfare. Venture capitalists can therefore be viewed as vendors of complementary components to either incumbents or public investors, who use complementarities in the component-based structure of technological innovation to both maximize profits and enhance consumer welfare.
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