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We model an employee's decision to pursue an innovative idea at his employing firm (internally) or as a start-up (externally). We characterize an idea by its market profitability and the degree of positive/negative externality that it imposes on the employing firm's profits. The innovation process consists of exploration and development. Exploring an idea internally grants the employee access to exploration support provided by the firm but reduces his appropriability of the idea. We demonstrate that ideas exhibiting weak externalities are explored and developed externally, whereas ideas with strong externalities are explored and handled internally. Moderate externalities are associated with internal exploration but subsequent external development. An increase in the firm's exploration support attracts internal exploration of a wider range of ideas but may increase the likelihood of subsequent external development. We further show that while the optimal level of exploration support rises with the firm's innovation appropriability, overall profits may decline.
