Shapes and determinants of returns to innovation

Innovations, as highly risky, costly and uncertain activities, are extremely selective, giving rise to only a small group of lucky winners with substantial returns. This paper builds on the observation that returns to both firm and market novelties (MNs) are significantly right-skewed and, with regard to effective R&D policies, establishes which theoretical distribution best resembles the observed distributions. It reveals that due to the systematic deviation of the returns from the Pareto power law, hedging against risk by allocating resources to large pools of innovators is a promising R&D policy approach. Moreover, the analysis also sheds light on the factors determining the differential shapes of the distributions of the returns to both firm and MNs. It highlights that both types of innovations considered are subject to very different selection mechanisms.