Seminar: Mikko Leppaemaeki, Helsinki School of Economics.

Titel: Innovation Finance, Human Capital and Intellectual Property Rights.

Abstract:

We examine a contracting problem between a penniless entrepreneur (E) and a wealthy financier (F), who finances an investment project, which is specific in a sense that to large extent it is only E who can complete the project and that E.s human capital/acquired expertise cannot be seized in the case of default or when E decides to leave the project. The key element in our analysis is E.s commitment problem as E can not commit not to leave the venture after learning at the interim stage - after the investment has been made but before completing the project - the increased value of his human capital/acquired expertise outside of the venture. In particular, if the value of his human capital/acquired expertise is high, E has an incentive to leave the venture and to complete the project outside on his own. We compare the two types of contracts, i.e., a commitment contract that keeps the entrepreneur within the venture with probability one and a non-commitment contract under which the entrepreneur stays only when the when the value of E.s human capital/expertise is low and leaves when it is high. Consequently, in equilibrium we have break aways only within the non-commitment contract. As a benchmark, we show first that the non-commitment contract is optimal only if the probability of the good state (the value of E.s human capital/expertise is high) is suffciently low, and the commitment contract is optimal when the probability of bad state (the value of E.s human capital/expertise is low) is small enough. We then show how intellectual property rights (IPRs) over the expected surplus of the venture modify the contracting problem by partially mitigating E.s commitment problem. We find somewhat counterintuitively that weak IPRs for the financier makes the non-commitment more profitable and strong IPRs for the financier makes the commitment contract more profitable. As we adopt a probabilistic view over the enforcement of IPRs allocation between E and F in case E leaves, certain IPRs allocations will introduce negative expected profits for the financier and thus credit rationing arises. In short, to balance E.s strong position due to possibility to walk away F must be granted stronger IPR protection. That is, reallocation of IPRs among E and F can resolve the credit rationing problem. Interestingly, we also find that a reduction of start up costs of E related to the case when E decides to walk away to complete a project on his own makes the credit rationing problem more severe. Finally we discuss the socially optimal allocation of IPRs among the entrepreneur and the financier.