Do Thick Venture Capital Markets Foster Innovation$\_?$ A Strategic Analysis

In this paper we examine how far the availability of venture capital influences the speed of technological progress in an industrial agglomeration. We consider a model where R\&D efforts of an incumbent firm generates technological know-how embodied in key R\&D employees, who might use this know-how to found a spinoff of the incumbent. Venture capital is needed to finance a spinoff, and therefore the expected profits from founding a spinoff depend on how easily venture capital can be acquired. Accordingly, thick venture capital markets might have two opposing effects. First, incentives of firms to invest in R\&D might be reduced and, second, the generation of spinoff firms, which leads to the diffusion and duplication of know-how, might be fostered. The trade-off between these two effects is first studied in the framework of a static game-theoretic analysis and then in a dynamic agent-based simulation model.