The measurement and management of risk in R&D and innovation

Abstract

This paper focuses on the issue of risk in the R&D and innovation processes. It examines the degree of risk suggested by the four main streams of the literature. While risk has not been a major focus of the empirical literature, the results suggest that the vast majority of inventions are worth relatively little, while a small proportion are extremely valuable. The second part of the paper argues that the net present value rule may not be appropriate in the presence of high risk, and the R&D decision may require an optimal stopping rule, which gives very different results. Adopting an optimal stopping rule in the face of a normal distribution of annual gross returns, the lifetime distribution of returns are similar to those observed in the real world. In addition, it is possible to use the results to replicate the observed behaviour of patent renewals.