Radical Innovation, Agency Costs and the Small Firm Advantage

Despite a number of disadvantages, small firms have been found to be effective developers of product innovations, including at times, radical innovations. This paper proposes an agency theory explanation for this phenomenon, arguing that small firms have lower agency costs in the new product development process when radical innovations are being developed. When a firm develops a radical innovation, the ability to monitor employees during the process may be limited, as will the cost effectiveness of monitoring. Similarly, it is proposed that performance metrics are likely to be imprecise and the firm will be inaccurate in providing rewards to employees. While this is arguably true regardless of firm size, it is also proposed that these monitoring difficulties will be more pronounced in large firms compared to smaller firms.