No Pain, no Gain: An R&D Model with Endogenous Absorptive Capacity

I investigate how the introduction of the absorptive capacity hypothesis changes the results of the strategic investment games with exogenous spillover. As a novelty, this paper distinguishes between two different components of R&D: "absorptive R&D" and "inventive R&D". It is demonstrated that a new effect appears: The "absorptive capacity effect" now counteracts the "free-rider effect" of the traditional models. The findings show that firms will invest more in R&D to strengthen absorptive capacity when the spillover parameter is higher. To learn from its competitor, a firm needs to develop its absorptive capacity: no pain, no gain!