| Abstract: |
Speculative industries exploit novel technologies subject to two risks. First,
there is uncertainty about the fundamental value of the innovation: is it
strong or fragile? Second, it is difficult to monitor managers, which creates
moral hazard. Because of moral hazard, managers earn agency rents in
equilibrium. As time goes by and profits are observed, beliefs about the
industry are rationally updated. If the industry is strong, confidence builds
up. Initially this spurs growth. But increasingly confident managers end up
requesting very large rents, which curb the growth of the speculative sector.
If rents become too high, investors may give up on incentives, and risk and
failure rates rise. Furthermore, if the innovation is fragile, eventually
there is a crisis, and the industry shrinks. Our model thus captures important
stylized facts of the financial innovation wave which took place at the
beginning of this century. |