Growing through spinoffs. Corporate governance, entry dynamics, and innovation

Abstract

New firms are often based on ideas developed within incumbent firms. We study spinoff activities in a growth model with entry and product quality innovation. Spinoffs increase aggregate productivity through product variety expansion and, if created voluntarily by incumbents, boost their return to equity. However, they erode incumbents' market share and, when stemming from conflicts between incumbents and employees, raise incumbents' internal cost of capital. The analysis reveals that a priori investment protection has an ambiguous impact on spinoff activities, depending on whether it focuses on incumbents' product quality investments or the creation of voluntary spinoffs. The calibrated model indicates that a broad investment protection reform reduces the spinoff rate but boosts incumbents' product improvement, raising income growth and welfare. The trade-offs are consistent with firm-level evidence from Italy.