Venture Capitalists, Asymmetric Information, and Ownership in the Innovation Process∗

In this paper we construct a model in which entrepreneurial innovations are sold into oligopolistic industries and where adverse selection problems between en-trepreneurs, venture capitalists and incumbents are present. We show that as ex-acerbated development by better-informed venture-backed firms is used as a signal to enhance the sale price of developed innovations, venture capitalists must be suf-ficiently more efficient in selecting innovative projects than incumbents in order to exist in equilibrium. Otherwise, incumbents undertake early preemptive, acquisi-tions to prevent the venture-backed firms ’ signaling-driven investment, despite the risk of buying a bad innovation. We finally show at what point the presence of active venture capitalists increases the incentives for entrepreneurial innovations