Essays in dynamic experimentation
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Innovation and knowledge are critical for the development of the modern economy. I design and study dynamic models for the funding of new research under different economic conditions. In the first essay, I develops a model for the funding of R&D initiated by an entrepreneur. In the model, the funding is undertaken by a large homogeneous pool of investors. The entrepreneur can bank present investment funds for either future experimentation or diversion. R&D activities are not observable. There are two main conclusions. First, even when entrepreneurs have full bargaining power, commitment and incentive problems imply that R&D is usually inefficiently funded. Second, stronger reporting enforcement can be welfare enhancing and improves the outcomes for the entrepreneur. In the second essay, I study funding of the projects at the early stages of the startup development. I search for the best feasible contract that can be signed by the entrepreneur and the investor. The contract provides dynamic incentives to work on the risky project in the presence of convex effort costs, private valuations, and developed credit markets. I reveal that the best feasible contract satisfies three main properties: funding is provided independent of the project failure or success; private valuations are internalized; and the work on the project does not stop until the project succeeds. In the third essay, I study how venture capitalists provide funds to entrepreneurs to finance risky projects that exhibit diminishing returns to scale. I show that the funding rates strictly decrease in time in the full information and the observable but unverifiable information environments. In the unobservable information environment, the funding rates eventually become strictly decreasing, but they may increase in the beginning.