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This is a review essay based on an important recent book, The Entrepreneurial State: Debunking Public vs. Private Sector Myths, by Mariana Mazzucato, a Professor of the Economics of Innovation. In that book, Professor Mazzucato explains how the U.S. Government, acting as an “entrepreneurial state” has made the critical investments in technologies that have given rise to multi-billion dollar new industries. Mazzucato argues that only the State currently has the funds and incentives necessary to finance the earliest and most important phases of the innovation process, investments the private sector cannot and will not make. Mazzucato’s defense of the centrality of government sponsorship of innovation is simultaneously a critique of the role of private entrepreneurs in the innovation process. Under Mazzucato’s theory, private entrepreneurs, even the vaunted venture capitalists of Silicon Valley, are necessarily latecomers to the innovation process. Their business model depends on diversification, and diversification requires a reasonable estimation of the risk/return relationship of any potential business investment.
To be sure, Mazzucatto recognizes that private capital has an important role to play. As new technologies become better understood, the tasks of developing their commercial applications and producing and marketing them with maximum efficiency are all likely to be handled better by the private sector. Even in this role, however, Mazzucato is highly critical of the performance of the private sector, believing that they invest too late, demand results too quickly, and expect too much in the return on their investments. It is here where Mazzucatto’s analysis becomes interesting to corporate lawyers. By criticizing current private investment in innovation as sub-optimal, she raises the question whether changes to the incentives and constraints on the managers of private capital might lead to greater and more cost effective innovation.
This essay seeks to pick up where Mazzucato leaves off, expanding and developing her critique of contemporary managerial and investor behavior with regard to innovation risk, and relating it to current debates on similar issues within corporate law. It raises the basic question of what is the purpose of corporate law. It shows how “dynamic” economic models like Mazzucato’s that focus on innovation and economic growth pose a challenge to traditional “static” models of corporate law which emphasis efficient use of existing resources. It then looks at the concerns about “short-termism” among corporate managers and other critiques of the “financialization” of private investment in innovation, comparing it to similar critiques within the corporate law literature about the dangers of short term shareholder profit maximization. It shows that this debate cannot be resolved through empirical analysis of existing investment activity or other event studies. Empirical studies based on subsequent stock price movements provide information only on average returns, and while it may well be true that on average, shareholder activism has improved managerial performance as measure by stock prices and other measures, such results cannot negate the possibility that some potentially valuable innovations did not occur as a result of such pressure. Such studies can give us no information on investments that have not been made and innovations that have not been discovered.
This essay argues that the greatest danger current corporate law and corporate finance pose to the innovation process is neither investor activism nor managerial inefficiency, but rather conformity of viewpoint within the financial community. Instantaneous global communication, increased competition among venture capital and private equity firms, the growth of shareholder activism and other factors have all tended to create an environment in which any firm pursuing an investment strategy currently deemed non-optimal by the market consensus is likely to be challenged and financially punished in various ways. Yet the very nature of innovation is that it is most likely to come from activity that is sufficiently vague, unclear or just plain weird, that it is unlikely to conform to most financial professionals’ idea of a “good investment.” This is a key part of Mazzucato’s argument why the state is an indispensible participant in innovation development, but it is also an important point for corporate lawyers and academics to keep in mind. Doing so would encourage those aspects of corporate law which enable firms pursuing unusual strategies to protect themselves from interference and disruption of business plans, controversial measures like dual class stock and contractual modifications of shareholder rights, which seem to be growing in popularity along with investor activism and managerial constraints. Viewing these debates from the perspective of innovation leads to a caution against overgeneralization and a recognition that innovation and growth will be best served if unusual investing activity is considered on a case by case basis, with a nuanced set of rules that reflects different levels of deference to managerial discretion in different circumstances.
Delaware Journal of Corporate Law
book review, economics, venture capital, technology, private sector, corporate law, finance
Intellectual Property Law | Law
Innovation, the State and Private Enterprise: A Corporate Lawyer's Perspective,
Delaware Journal of Corporate Law