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Market-Based Solutions to Vital Economic Issues
Research
Nov 30, 2017

Innovation Waves, Investor Sentiment, and Mergers

Abstract

We develop a theory of innovation waves, investor sentiment, and merger activity based on uncertainty aversion. Investors must typically decide whether to fund an innovative project with very limited knowledge of the odds of success, a situation best described as “Knightian uncertainty.” We show that uncertainty-averse investors are more optimistic on an innovation if they can also make contemporaneous investments in other innovative ventures. This means that uncertainty aversion makes investment in innovative projects strategic complements, which results in innovation waves. Innovation waves occur in our economy when there is a critical mass of innovative companies and are characterized by strong investor sentiment, high equity valuation in the technology sector, and “hot” IPO and M&A markets. We also argue that M&A promotes innovative activity and leads to greater innovation rates and firm valuations.

Note: Research papers posted on SSRN, including any findings, may differ from the final version chosen for publication in academic journals.


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