Strategic delay in a real options model of RD competition, Review of Economic Studies, for.pdf

STRATEGIC DELAY IN A REAL OPTIONS MODEL OF RD COMPETITION Helen Weeds No 576 WARWICK ECONOMIC RESEARCH PAPERS DEPARTMENT OF ECONOMICS STRATEGIC DELAY IN A REAL OPTIONS MODEL OF RD COMPETITION HELEN WEEDS Department of Economics, University of Warwick 20 September 2000 Abstract This paper considers irreversible investment in competing research projects with uncertain returns under a winner-takes-all patent system. Uncertainty takes two distinct forms: the technological success of the project is probabilistic, while the economic value of the patent to be won evolves stochastically over time. According to the theory of real options uncertainty generates an option value of delay, but with two competing firms the fear of preemption would appear to undermine this approach. In non-cooperative equilibrium two patterns of investment emerge depending on parameter values. In a preemptive leader-follower equilibrium firms invest sequentially and option values are reduced by competition. A symmetric outcome may also occur, however, in which investment is more delayed than the single-firm counterpart. Comparing this with the optimal cooperative investment pattern, investment is found to be more delayed when firms act non- cooperatively, as each holds back from investing in the fear of starting a patent race. Implications of the analysis for empirical and policy issues in RD are c