PRIVATE INFORMATION AND INVENTIVE ACTIVITY

This paper examines incentives for investment in inventive activity in an environment subject to informational constraints. On the one hand the inability of the public to monitor such investments suggests that inventors should bear a high share of the risk associated with their efforts. on the other hand, the very novelty of an invention could make it difficult to sell to a skeptical public. This difficulty could induce an inventor to engage in costly signalling activity. This papers considers this friction, and the nature of contracts which balance the incentive to invent against the incentive to signal. Optimal contracts are interpreted in terms of financial arrangements between entrepreneurs and investors.