Abstrakt
We analyze innovation races in a moral hazard setting. We develop a model where 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 stage of R&D.
Moreover, it holds for a large range of parameters also when the entrepreneurs are at the different stages of R&D, so that one of them is the leader in the innovation race and the other is the follower.