Determinants of Mode of Innovation in IT Firms

In the research, we investigate the role of diversification in the type of innovation strategy followed by incumbent firms in the IT industry. We setup a two-stage game theoretic model where, in the first stage, the incumbent decides whether to invest in R&D or acquire a pre-emptive stake in the entrant. In the second stage, the incumbent decides whether or not to acquire a successful entrant. Our main result is that a more diversified incumbent is more likely to invest in acquisition than engage in R&D. We also collect data on financial indicators for firms in the IT industry using the Compustat database to empirically test our main result. Our empirical model confirms our proposition that firms with a degree of diversification are more likely to innovate through acquisition than through R&D.