This study provides relevant complementary insights to the literature on the economics and management of innovation, which has identified important barriers that prevent firms from initiating and successfully completing innovation projects. It proposes that by developing and 11 Due to funding reasons, in even years, MIP survey waves employ a much shorter questionnaire focusing only on the most essential items. Thus, some of the variables we include in our main specification are not available in the 2010 wave and we are thus forced to carry out these estimations with a smaller set of controls.
financing innovation projects in stages, firms can increase their learning while reducing their costs. The findings of this study show that by staging their investments in innovation, firms are able to initiate more innovation projects and also abandon a higher number of unpromising ones.
Interestingly however, this effect is only present in resource-constrained firms but not in resource-abundant firms, as the latter are characterized by overoptimism and managerial discretion, which impede adequate resource reallocation in staged innovation projects. The positive news is that for those firms that face higher barriers to innovation, i.e. that are more resource-constrained, a staged-approach to innovation projects clearly helps to overcome these barriers. As such, this study complements recent work by Danneels and Vestal (2020), who show that in order to learn from past (failed) projects, organization members need to critically analyze these projects, and do this in a climate of constructive conflict that allows for honest and open discussion. Our findings suggest that the staging of innovation projects may allow constrained firms to do this, but will not suffice to overcome the cognitive biases of resource-abundant firms (D’Este et al., 2012; Leoncini, 2016; Pellegrino and Savona, 2017).
Second, this study also supports the recent evolution in the literature on the economics and management of innovation to look at general innovation performance, and not merely project abandonment as outcomes of learning from past experience and failure (Danneels and Vestal, 2020; Leoncini, 2016). As Edmondson (2011) explains, not all abandoned projects reflect bad innovation performance: experiments that lead to a rejection of previously held assumptions can in fact be very valuable. Our study advances the idea that when it comes to unpromising projects, early abandonment is actually preferable over continued investment, meaning that project abandonments can be an indicator of good rather than bad innovation performance. We hope that future studies take these insights into account when investigating the effects of learning (from failure).
Third, this study responds to a repeated call in the literature for a more contingent view on
real options reasoning (Driouchi and Bennett, 2012; Tong and Reuer, 2006, 2007) and on project management in general (Loch, 2000; Phillips, Noke, Bessant, and Lamming, 2006; Biazzo, 2009). Although the limitations of the option model in the light of cognitive biases are discussed in the real options literature, there have been few systematic approaches to study under which conditions firms are likely to depart from the entirely rational real options logic and how this then affects their investment decisions. As Ragozzino et al. (2016) explain, both the financial economics and strategy literatures have produced a significant stream of studies supporting the use of real options as a decision-making mindset or tool. However, instead of building on each other’s insights, these two fields have developed quasi-independently. Ragozzino et al. argue that for real options to develop into a core pillar of strategic management theory, it needs to integrate firm heterogeneity and investigate how differences between firms affects the implementation and effects of real options reasoning. We believe our study makes an important contribution towards this goal. By focusing on the firm as a unit of analysis, as suggested by Ragozzino et al., we provide generalizable, quantitative evidence that resource-abundant and resource-constrained firms differ in the way they take decisions under a staged investment approach.
A fourth contribution of the current study is that it relaxes the assumption of
“hyperrationality” (Miller and Arikan, 2004) that typically dominates the real options literature.
We are – to our knowledge – the first to systematically discuss how overoptimism affects a firm’s assessment of the decision parameters in a real option evaluation model. Moreover, we theoretically discuss and empirically show that these biases are different for resource-abundant and resource-constrained firms. As Ragozzino et al. (2016) explain, previous work has not adequately addressed the effect of decision-making biases and agency hazards on firms’ ability to implement and benefit from real options reasoning (Ragozzino et al., 2016). The results of our study clearly suggest that the managers of resource-abundant firms are more overoptimistic and
have higher levels of managerial discretion, i.e. they face more relaxed internal monitoring, than the managers of resource-constrained firms, and therefore make far less use of the possibility to initiate or abandon more projects, which a staged investment approach supposedly offers.
As Adner and Levinthal (2004) already argued, a sequential stream of investment in and of itself does not constitute a real option. The current study empirically demonstrates that the mere decision to stage investments does not necessarily imply that the potential effects of a real options approach will be realized, and that future studies will have to take firm characteristics pertaining to resource availability, biases, and control into account when investigating the impact of staging – and decision-making rules inspired by real options reasoning more in general – on firms’ investments decisions.