17. encouraging profitable investment24 Ralph’s firm is always looking for new, innovative products. A manager in Ralph’s firm every now and then discovers a new product.

Any such discovery is privately known, and it is up to the manager to reveal to Ralph the new product idea. Any new product will eventually result in success (S) or failure (F). The odds of success are higher if the manager is of higher talent. This is because higher talented managers are better at identifying high-quality projects and are also better at implementing them. People inside and outside the firm observe whether a new product proposal is brought forward, and whether it succeeds or fails. In this way, the labor market learns when a particular manager brings forward a new product and whether that product turns out to be successful. (Gossip can be quite powerful.)

The manager’s reputation, in other words, improves if a product proposal is brought forward and if the product turns out to be successful.

A failed product lowers the manager’s reputation. No product proposal is a somewhat intermediate story, because we have to worry about whether the reputation is influenced by a lack of proposal.

Let’s forget about this latter possibility.

Any new product is risky to Ralph’s firm; it is also risky for the proposing manager as any such investment proposal places that manager’s reputation at risk. What does this do to product development incentives in Ralph’s firm, and what might Ralph do to address the situation?