Financial innovation and first-mover advantages

Abstract

This paper uses a database of 58 financial innovations from 1974–1986 to examine how investment banks are compensated for their investments in developing new products. Investment banks that create new products do not charge higher prices in the brief period of ‘monopoly’ before imitative products appear, and in the long-run charge prices below, not above, those charged by rivals offering imitative products. However, banks capture a larger share of underwritings with innovations than with imitative products. One interpretation of the price and quantity evidence is that innovators become inframarginal rivals that enjoy lower costs of trading, underwriting, and marketing.