Firm Dynamics, Private Informa- Tion, and the Generation of New Technology Nonresponse Bias in Cpi Measures for Rents

FIRM DYNAMICS, PRIVATE INFORMATION, AND THE GENERATION OF NEW TECHNOLOGY The authors present a theory of spinoffs in which the key ingredient is the originator’s private information concerning the quality of his new idea. Because quality is privately observed, by the standard adverse-selection logic, the market can at best offer a price that reflects the average quality of ideas sold. This gives the holders of above-average-quality ideas the incentive to spin off. The authors show that only workers with very good ideas decide to spin off, while workers with mediocre ideas sell them. Entrepreneurs of existing firms pay a price for the ideas sold in the market that implies zero expected profits for them. Hence, firms’ project selection is independent of firm size, which, under some additional assumptions, leads to scale-independent growth. The entry and growth process of firms leads to invariant firm-size distributions that resemble the ones for the U.S. economy and most of its individual industries. Working Paper 08-26, “Spinoffs and the Market for Ideas,” Satyajit Chatterjee, Federal Reserve Bank of Philadelphia, and Esteban RossiHansberg, Princeton University, and Visiting Scholar, Federal Reserve Bank of Philadelphia