Optimal R&D investments of the firm

This paper examines irreversible decisions on innovative activities where it takes time to complete an R&D project. The total amount of R&D investments that the firm needs to undertake in order to obtain the breakthrough in the innovation process is uncertain. R&D investments are limited by the restriction that they must be self-financed. It is shown that R&D investments are more valuable when the level of uncertainty is large. Especially, it is very attractive to undertake R&D investments if a project faces many uncertainties during its early phases. Furthermore we study how R&D behavior is influenced by different levels of the discount rate and the financing limit. Moreover, the effects of R&D subsidies, spillover benefits and a payoff that decreases over time are analyzed.