We develop a simple model of competition for the market that shows that, contrary to the Arrow view, endogenous entry threat in a market induces the average firm to invest less in R&D and the incumbent leader to invest more. We test these predictions with a Tobit model based on a unique dataset and survey for the German manufacturing sector (the Mannheim Innovation Panel). We confirm the empirical validity of our predictions and perform a number of robustness test with instrumental variables.
Czarnitzki, Dirk, Federico Etro and Kornelius Kraft (2008), The Effect of Entry on R&D Investment of Leaders: Theory and Empirical Evidence, ZEW Discussion Paper No. 08-078, Mannheim. Download