Because of the inherent uncertainty, promotion of innovation critically depends on screening mechanisms to select projects. This paper studies the relationship between bureaucracy and financial constraints as two such mechanisms. The lack of commitment to hard financial constraints interferes with its ex post screening capability; ex ante bureaucratic screening is optimally chosen as a substitute. However, bureaucracy makes mistakes by rejecting promising projects and delays innovation, and the efficiency loss due to soft financial constraints increases as prior knowledge becomes worse and as research stage investment requirements become lower. In a centralized economy, bureaucracy may reduce the number of parallel projects, particularly for projects with higher uncertainties and less research stage requirements. This theory fits much of the evidence and in particular it explains why the computer industry, but not the nuclear or aerospace industries, has fared so poorly in centralized economies.

The fundamental importance of economic institutions for economic growth through their impact on technological change has long been argued by Joseph Schumpter and others. Recent empirical studies have reconfirmed such arguments. Robert Barro (1997) finds that economic and political institutions are the most important factors in explaining differences in growth across economies. New growth theory has made major breakthroughs in endogenizing technological changes. However, although some insightful and inspiring discussions of institutional impacts of innovation are provided, there is little attempt in these models to explain what, aside from capital, labor inputs, and knowledge accumulation, determines innovation. An attempt is made to fill the gap in literature by examining how financial institutions affect technological innovation and thus affect growth.

We compare the performance of organizational forms (M‐form and U‐form) in experimenting with uncertain projects. In our framework, organizational forms affect the information structure of an organization and thus the way to coordinate changes. Compared to the U‐form, the M‐form organization achieves better coordination in “attribute matching” but suffers from coordination in “attribute compatibility” and less gains in specialization. The distinctive advantage of the M‐form is its flexibility in choosing between small‐scale and full‐scale experimentation.

The design and implementation of privatization in China is unique in that both are decentralized and administered by the local governments. Based on a proprietary survey data set containing 3, 000 firms in over 200 cities, this paper studies privatization choices and outcomes, as well as the mechanism behind the outcomes. We find that less political opposition to labor downsizing and greater fiscal capacity prompt cities to choose direct sales to insiders (MBOs). This method transfers control rights to private owners, retains limited government supports, imposes hardened budget constraints, allows for restructuring, and achieves performance improvement. Received September 8, 2015; editorial decision February 3, 2017 by Editor Andrew Karolyi.