PREEMPTIVE RESEARCH-AND-DEVELOPMENT, RENT DISSIPATION, AND THE LEVERAGE THEORY

This paper provides a new perspective on the validity of the so-called ''leverage theory.'' In a model of preemptive innovation in ''systems '' markets, I examine the effect of bundling on R&D incentives. I find that bundling provides a channel through which monopoly ''slack'' in one component market can be shifted to another, with the effect of mit igating rent dissipation in the systems market. Bundling can be profit able if this beneficial effect of reduced rent dissipation outweighs t he negative effect of intensified price competition. After demonstrati ng the private optimality of bundling, its welfare implications are co nsidered. Finally, the results can be reinterpreted to analyze the rel ationship between compatibility decisions and R&D incentives in mix-an d-match models.