Cash breeds Success : An Examination of the Role Financing Constraints in Innovation Races

This paper studies the impact of cash constraints on equilibrium research intensities in a patent race between a current owner of the “state of the art” technology (the incumbent) and entrants. We develop a simple model, where players need to raise funds from imperfectly informed creditors to finance their research. The model delivers testable comparative statics predictions for the impact of players’ wealth on equilibrium research: the incumbent faces better prospects of winning the race the less cash-constrained he is and the more cash-constrained the entrants are. For industries with capital intensiveresearch technologies we found that financial market im perfections may reverse the model’s predictions from leapfrogging (Jennifer Reinganum) to persistence of monopolies (Richard Gilbert and David Newbery). We test these predictions empirically using evidence from patents awarded between 1975 and 1999 in the US. We fit probabilistic regressions of the predicted equilibrium probabilities on indices of the financial wealth of incumbent and potential entrants. We focus on the pharmaceutical industry, where all innovations are patented and each patent award is in itself a race for the next innovation. Since the incumbent/entrant status of the players is not directly observable from existing databases, we proposea novel methodology to identify the players’ status from the patent data: we call the patent assignee an entrant if none of the patents that are cited by the given patent were obtained by him. Otherwise, an assignee was an incumbent to the race. We merge the data from the NBER patent database with COMPUSTAT to obtain the financial information of the players, such as retained earnings, and the value of liquid assets.