The importance of spillovers from research and development (R&D) expenditure to firms’ innovation efforts (Jaffe, 1986, 1988; Griliches, 1991) is widely acknowledged. Firms’ investments in knowledge-related activities leak into the environment where these spillovers can be appropriated by other firms. Existing literature focuses on intra- or inter-organizational exploratory search efforts; however, we have limited understanding of how knowledge spillovers (hereinafter spillovers) from within (horizontal) and across (vertical) industries impact firms’ decisions to engage in exploration -- that is, activities related to new search, risk-taking, and experimentation (March, 1991). We investigate: do horizontal and vertical spillovers in the environment facilitate or deter firm exploration efforts?

We posit that firms operating in environments with high levels of horizontal spillovers have limited incentives to pursue exploration as knowledge from this activity will flow to competitors. We also consider the impact of vertical spillovers from upstream and downstream firms which require the focal firm to adapt its technology portfolio based on the knowledge pools in the vertical value chain. As vertical restraints limit the scope of a firm’s strategic actions (Rey and Tirole, 1986), vertical spillovers may dissuade the focal firm from engaging in exploratory search.