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Financing Disruption? Armour & Enriques

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Discussant

Allen Ferrell, Harvard Law School

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Big Topic

1. Institutional structure that supports firm-level innovation

2. A little more specifically: Potential benefits of linking supply of capital with knowledge of the project

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Two Literatures

1. Venture Capital Literature: Gompers & Lerner; Gilson (“braided contracts”)

2. Innovation at the firm-level:

See, e.g., Aghion, Reenen & Zingales (2013); Bernstein (2015)

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General comments on exposition

1. Distinguish between information asymmetry and incomplete information stories

2. Distinguish between market efficiency and market inefficiency stories

3. Specific about the most important source of market failure in their opinion

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What’s the problem?

1. Stein (1988) story: managers judged on what can be observed which then affects incentives.

See also Aghion, Reenen & Zingales (2013)

2. Pooling of good and bad innovation projects by the market which then affects incentives to engage in innovation.

In this story, market still gets it right on average

3. Undervaluation of innovation

Market inefficiency story

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Some selective evidence

(1) Fama-French book-to-market factor

Lakonishok, Shleifer & Vishny (1994): low returns on growth indicates market overvalues growths stocks

(2) Fama & French (2002): IPO incidence of low-profitability high-growth firms is a long-term phenomenon

(3) Eberhart et al (2004): market under-reacts to increases in R&D

Cifci, Lev and Radhakrishnan (2009): same as Eberhart but firm-level earnings guidance removes this

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(4) Bernstein (2015): Firms that have an IPO do less innovation

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What does this mean for policy?

(1) Is there a market failure?

“Central problem [is] the strictly limited pool of expertise regarding a new technology.”

Returns to acquiring expertise (venture capital, institutional investor)

(2) Are IPOs the wrong focus assuming we want to encourage innovation?

(3) Maybe some innovation is wasteful

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Externalities to basic research

(1) Governmental funding of scientific research

(2) Prizes

(3) Give money to universities