Title: A prospect theory model of R&D allocation and invention
Description: In contrast to the substantial literature on how firms should allocate R&D, less research addresses how managers actually allocate R&D funds across potential projects. We develop two models of R&D resource allocation under risk, based on assumptions of utility maximization and behavioral mechanisms of prospect theory. The models assume consistent but not profit-maximizing behavior and demonstrate how resources, managerial risk propensity, and aspiration reference levels interact to influence the level of R&D spending, the expected number of patents, and the probability of a breakthrough patent. The behavioral assumptions of prospect theory result in predictions of hunger-driven innovative search and breakthroughs; surprisingly, the same assumptions also predict slack-driven search breakthroughs.