Developing New Ideas: Spin-outs, Spinoffs or Internal Divisions

This paper offers a theory of how ideas generated by the employees of a firm are implemented. An idea can be developed in an independent new firm created by the employee (spin-out), or benefit from an investment by the parent employer and be implemented in an internal division or in a spinoff. Employees privately observe the value of their ideas, hence keeping those with good ones comes at a cost of increased wages for all employees. Developing an idea in a spinoff whose performance is verifiable by third parties, allows the principal to offer performance based contracts, mitigates the agency problem and improves the efficiency in the parent’s core activity. However, when the fraction of bright ideas is small the overall increase in wages may lead the firm to let the employees with good ideas leave and innovation is implemented in spin-outs. The paper also relates the creation and survival rates of new ventures to the parent’s performance. It shows that better performing firms have higher spin-out creation rate and spawn better performing spinoffs and spin-outs