The Returns to Investments in Innovative Activities: An Overview and an Analysis of the Software Industry

  • Josh Lerner
Part of the The Milken Institute Series on Financial Innovation and Economic Growth book series (MILK, volume 2)


The distribution of the returns to innovative activities, whether in the software industry or more generally across high-technology industries, is highly uneven. A small number of firms account for the bulk of the returns. An extensive theoretical literature on technological competition suggests that this empirical regularity is not surprising. This is true not only in high-technology firms in general, but also in the software industry specifically.

Moreover, predicting the success of high-technology firms is exceedingly difficult. Information problems and the intangible nature of the companies’ assets make it difficult for investors to avoid making numerous unsuccessful investments for each successful one. If investors are denied profits from even a handful of their most successful investments in innovative activities, their overall return is likely to fall dramatically.

Finally, this highly skewed distribution of rewards has substantial implications for the designers of regulatory policy. Because it is often impossible to predict which innovations will succeed, investors need to be assured that they will receive substantial returns from successful investments to offset the unsatisfactory returns from the many failed or less successful projects. If investors believe that they will be denied these returns by regulators, their willingness to fund the development of the next generation of innovative technologies will be greatly reduced.


Venture Capitalist Initial Public Offering Private Equity Innovative Activity Harvard Business School 
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© Kluwer Academic Publishers 2002

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  • Josh Lerner

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