Tacit knowledge with innovative entrepreneurship

Tacit knowledge affects the trade-off between entrepreneurship and technology transfer. I present a formal model in which an inventor and the existing firm engage in a strategic innovation game by choosing whether to compete or to cooperate through technology transfer. The model highlights how the problem of tacit knowledge affects the inventor's R&D investment and the existing firm's investment in absorptive capacity. The inventor's tacit knowledge implies that benefits from own-use through entrepreneurship can exceed the benefits from technology transfer. In equilibrium, higher-quality inventions result in entrepreneurship and lower-quality inventions result in technology transfer. R&D investment and absorption investment are strategic substitutes in the innovation game with the option of entrepreneurship. The possibility of entrepreneurship increases R&D investment and reduces absorption investment. The equilibrium probability of entrepreneurship is decreasing in the costs of R&D, increasing in the costs of absorption, and decreasing in the set-up costs of new firms.