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In this paper the authors examine the evolution of network formation. They present a model in which companies in an industry can innovate alone or in alliance with others. Alliance formation is based on the cognitive distance of companies: if two companies form an alliance, their probability of success in innovation depends on their proximity in knowledge space, that is, their cognitive distance. Knowledge, on the other hand, is modelled in two dimensions: breadth and depth. The main results of the analysis are that in the present setting heterogeneity decreases among companies whilst innovation can increase and decrease also, depending on the initial parameters of the industry's knowledge endowment.
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