Information Acquisition and Innovation Under Competitive Pressure

This paper studies information acquisition under competitive pressure and proposes a model to examine the relationship between product market competition and the level of innovative activity in an industry. Our paper offers theoretical support for recent empirical results that point to an inverted-U shape relationship between competition and innovation. The model presents an optimal timing decision problem where a firm endowed with an idea trades the benefits of waiting for additional information on whether this idea can be converted into a successful project against the cost of delaying innovation: a given firm's profit following innovation is decreasing in the number of firms that invested at earlier dates. By recognizing that a firm can intensify its innovative activity on two dimensions, a risk dimension and a quantitative dimension, we show that firms solve this trade-off precisely so as to generate the inverted-U shape relationship. The dynamic setup of our model offers insights not just in the cross-section on the relationship between competition and innovation, but also intertemporally on the optimal timing of innovation at firm level.