Publications & Working Papers
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Venture Capital and Industrial "Innovation"

(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1242693)

Joint with Masayuki Hirukawa.

Abstract: For the sample period of 1965-1992, Kortum and Lerner (2000) find that venture capital (VC) investments have a positive impact on patent count at industry level, and this impact is larger than that of R&D expenditures. We confirm that this positive impact continued to be present and became even stronger in late 90s during which VC industry experienced an unprecedented growth. We then proceed to study if this positive impact of VC is also present on productivity growth, which is a measure of innovation alternative to patent count. Unlike the impact on patent count, we do not find that VC investment affects total factor productivity growth. We do find that VC investment is positively associated with labor productivity but this positive impact is originated from the technology substitution from labor to other productive inputs such as energy and material. Therefore, our finding suggests that, at industry level, VC investment increases the patent propensity but may not necessarily improve the productive efficiency. Various interpretations are offered why this may be the case.

Covered by Business Week (Vivek Wadhwa, "Does Venture Capital Spur Innovation?" September 30, 2008).

Policy version available as "The Tenuous Tradeoff of Venture Capital and Innovation" in Vox (http://www.voxeu.org/index.php?q=node/2919).

Venture Capital and Innovation: Which is First?

(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1242698)

Joint with Masayuki Hirukawa.

Abstract: Policy makers typically interpret positive relations between venture capital investments and innovations as an evidence that venture capital investments stimulate innovation ("VC-first hypothesis"). This interpretation is, however, one-sided because there may be a reverse causality that innovations induce venture capital investments ("innovation-first hypothesis"): an arrival of new technology increases demands for venture capital by driving new firm startups. We analyze this causality issue of venture capital investments and innovation in the US manufacturing industry using both total factor productivity (TFP) growth and patent counts as measures of innovation. Using a panel AR regression as well as industry-by-industry AR regressions, we find that TFP growth is often positively and significantly related with future VC investment, which is consistent with the innovation-first hypothesis. We find little evidence that supports the VC-first hypothesis. More surprisingly, one-year lagged VC investments are often negatively and significantly related with both TFP growth and patent counts.

Risky Businesses

(available upon request)

Joint with Martin Ruckes.

Abstract: A risky business fails most of times but it generates an extremely high profit occasionally. We show that such a business has a lower value than a safer business when experimentation is needed to validate the business. Two factors disfavor a risky business relative to a safer business. First, a safer business has a higher chance of generating success and thereby a higher chance of validation and acceptance. Second, the option to discontinue the business after failure is less valuable if it is risky because failures in the risky business do not severely damage the prospects of the business. Taken together, our paper reveals a new channel through which the emergence of a risky business is hampered.

R&D and Markets for New Knowledge over Firms' Life-cycles

(http://masakoueda.com/document/RDMarket.pdf)

Joint with Kyriakos Frantzeskakis.

Abstract: Our theory of a firm's life-cycle emphasizes that a new firm is born uninformed about what type of knowledge it can implement but may learn that by experimenting, i.e. attempting to implement knowledge. Experimenting may result in losses and therefore the new firm may sell its knowledge to another firm instead of experimenting. Nevertheless, by doing so, the new firm will lose the option to learn what type of knowledge it can implement. We study stationary industry equilibrium of a continuous-time infinite horizon economy and characterize directions and volumes of markets for knowledge. We find that an established firm buys knowledge, whereas a young firm does not. Which an established firm or a young firm sells knowledge depends on costs of creating, implementing and selling, knowledge.

A Theory of Young Firm Acquisition

(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=992533)

Joint with Kyriakos Frantzeskakis.

Abstract: Evidence suggests that young firm acquisitions have outgrown both IPOs and established firm acquisitions. To study this phenomenon, we develop a dynamic equilibrium model of mergers and acquisitions as efficient reallocation of assets. A firm may build assets that it may not be able to manage successfully. If so, the firm may be acquired by an established firm that has proved its ability to manage such assets successfully. A young firm has not yet proved its ability to manage assets, and can only do so by remaining independent and managing assets. We find that when the transaction costs of acquisition decrease and/or the costs of building and managing assets increase, an established firm switches from building new assets internally to acquiring a young firm. We also find that when the young firm's attempt to manage assets are less likely to fail and/or assets obsolete sooner, more young firms become acquisition targets and the fraction of independent young firms such as IPO firms declines. Our model is consistent with some stylized facts of mergers and acquisitions such as the bidder discount, the target premia and the size distribution of acquirers and targets.

Law and Entrepreneurship: Do Courts Matter?
Entrepreneurial Business Law Journal 2(1), 353-364.

(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=943520)

Joint with D. Gordon Smith

Abstract: In this essay, we sketch the outlines of a research agenda exploring links between courts and entrepreneurship. Our conception of "law and entrepreneurship" encompasses the study of positive law (including constitutions, statutes, and regulations), common law doctrines, and private ordering that relate to "the discovery and exploitation of profitable opportunities by new firms." We briefly survey the economics literatures that relate to law and entrepreneurship, including the ?law and finance? literature launched by the work of Rafael La Porta, Florencio Lopez-de-Silanes, Andrei Shleifer, and Robert Vishny ("LLSV"). Relying on the suggestive work of LLSV and other economists who have labored over the connections between entrepreneurship and law, we suspect that courts may play an important role in facilitating or hindering entrepreneurial activity. We are particularly interested in the possibility that courts may facilitate the evolution of legal rules to address novel issues raised by entrepreneurial firms. This "adaptability hypothesis" may be subject to empirical testing, thus shedding light on the otherwise perplexing divide between common law and civil law countries identified by LLSV. The motivation for such a test lies in the conjecture that common law countries update their laws more frequently than civil law countries through judicial intervention. Adaptability in this sense is said to encourage entrepreneurship because outmoded laws allow for opportunism, thus discouraging capital formation. The adaptability hypothesis implies that judges in common law systems have more room to maneuver than judges in civil law systems, and we describe the method by which we intend to approach our future study of adaptability.

Why do Reputable Agents Work for Safer Firms?
forthcoming in Finance Research Letters.

(https://mywebspace.wisc.edu/mueda/web/document/liueda_freslet.pdf)

Joint with Fei Li.

This is a short version of the theoretical part in the following paper "CEO-Firm Match and Principal-Agent Theory"

Abstract: Safer firms receive funding from reputable venture capitalists and offer new securities underwritten by reputable investment banks. We offer a new explanation for these facts employing a moral-hazard model in which a firm and an agent are matched endogenously. If the agent is reputable, since she is more talented, her effort has a higher impact on output than otherwise. If the firm is safer, its output reflects the agent's hidden effort more accurately and, as a result, the agent's pay scheme tied with the output powerfully motivates her to exert effort. In equilibrium, a safer firm should be matched with a reputable agent since this combination allows to maximize effort of the reputable agent and minimizes deadweight costs associated with the moral hazard problem.

CEO-Firm Match and Principal-Agent Theory

(http://papers.ssrn.com/sol3/papers.cfm?abstract_id=740648)

Joint with Fei Li.

Abstract: We study the matching problem between firms and CEOs, extending a popular version of the principal-agent model developed by Holmstrom and Milgrom (1987). In their model, the optimal pay-performance sensitivity decreases in firm risks and agent's risk aversion, and increases in agent's productivity. We show that a more productive CEO (agent) should manage a safer firm in the matching equilibrium because the effort level of such a CEO is more responsive to high pay-performance sensitivity. As a consequence, a more productive CEO and a safer firm, where pay-performance sensitivity is high, form a winning combination for circumventing the effort underprovision problem. We also find the counterintuitive result that a more risk averse CEO should run a riskier firm for reasonable parameter values. Finally, we examine if the data support the negative relation between CEO's productivity and firm risks predicted by the theory.

Optimal Project Rejection and New Firm Start-ups
Management Science 52(2), 2006.

Joint with Bruno Cassiman.

Abstract: We study the decision of an established firm to commercialize innovations. An innovation can be exploited by the established firm as an internal venture, pursued by a new firm start-up as an external venture, or not commercialized at all. The limited commercialization capacity of the established firm in the short run results in an option value of waiting. In this setup, start-up firms emerge when the established firm is generating many innovations and/or selective because the option value of waiting is high. The model predicts that innovations commercialized through internal ventures are characterized by a higher fit with the internal resources of the established firm, a higher cannibalization of the established firm’s existing businesses, and a lower profitability than innovations commercialized through external ventures. The model furthermore generates predictions on the effect of spin-offs on firm value and on the relation between firm performance and spin-off performance.

Banks versus Venture Capital: Project Evaluation, Screening, and Explopriation
Journal of Finance 59(2), 601-621, 2004

Abstract: Why do some start-up firms raise funds from banks and others from venture capitalists? To address this question, I study a model in which the venture capitalist can evaluate the entrepreneur’s project more accurately than the bank but can also threaten to steal it from the entrepreneur. Consistent with evidence regarding venture capital finance, the model implies that the characteristics of a firm financing through venture capitalists are relatively little collateral, high growth, high risk, and high profitability. The model also suggests that tighter protection of intellectual property rights encourages entrepreneurs to finance through venture capitalists.

Stock Returns and Inflation in a Principal Agent Economy
Journal of Economic Theory 82(1), 223-247, 1998.

Joint with Boyan Jovanovic.

Abstract: We study a monetary system in which final goods sell on spot markets, while labor and dividends sell through contracts. Firms and workers confuse absolute and relative price changes: A positive price-level shock makes sellers think they are producing better goods than they really are. They split this apparent windfall with workers who get a higher real wage. Hence, unexpected inflation shifts real income from firms (the principals) to workers (the agents), and thereby lowers stock-returns. A predictable money-supply rule strictly Pareto-dominates random money-supply rules.

Contracts and Money
Journal of Political Economy 105(4), 700-708, 1997.

Joint with Boyan Jovanovic.

Abstract: Why are contracts not fully indexed? In a setting in which fully indexed contracts are feasible, we find that when price-level data are gathered with delay, these contracts are not renegotiationproof. The contracts that replace them entail a lower level of welfare for the parties to that contract. They also imply that real variables respond to nominal shocks.

Endogenous Timing in the Switching of Technology with Marshallian Externalities
Journal of Economics (Zeitschrift für Nationalökonomie) 63(1), 41-56, 1996.

Joint with Toshihiro Matsumura

Abstract: We analyze endogenous timing in the switching of technology. Each user chooses when to purchase a new product which embodies new technologies characterized by Marshallian externalities. The technological switch occurs when a large number of users purchase new products. Under complete information, multiple market equilibria exist, and one of the equilibria in which technological switching occurs is efficient. However, if we introduce even a small amount of uncertainty, the switch is delayed in the unique equilibrium under perfect competition, resulting in a loss of social welfare. The market power of a monopolistic supplier of new products alleviates this inefficiency.