Moonshots, Investment Booms, and Selection Bias in the Transmission of Cultural Traits
Abstract
Biased information about the payoffs received by others can drive the evolution of innovation, risk-taking, and investment booms. We study this social phenomenon using a model based on two premises. The first is a tendency for large successes, and the actions that led to them, to be more visible and salient to onlookers than failures. For example, Google is more familiar than numerous failed startups. The second is selection neglect, the failure of observers to adjust for such biases. In our model, each firm in sequence chooses to adopt or to reject a project that has two possible payoffs, one positive and one negative. The probability of success is higher in the high state of the world than in the low state.Adopting is on average profitable only in the high state. Each firm observes the payoff received by past adopters before making its decision, but there is a chance that any adopter's low-payoff outcome will be censored. Failure to account for this biased censoring causes later firms to become overly optimistic about the state of the world. We show how this induces irrational booms in adoption, which may later collapse, or which can even last forever in the low state. In particular, we find high rates of irrational long-run adoption for both moonshot projects and sure-bet projects, which feature either large but unlikely returns, or small likely returns. We interpret our results in the context of social evolution, where we treat adoption or rejection as a cultural trait transmitted between firms. A decomposition of trait change using the Price Equation reveals that the evolution of project adoption is driven by opposition between mutation pressure and evolutionary selection. This account provides a new explanation for investment booms, merger and IPO waves, and waves of