Adverse Selection and Financing of Innovation: Is There a Need for R&D Subsidies?
44 Pages Posted: 1 Jan 2009
Date Written: September 12, 2008
Abstract
We study the interaction between private and public funding of innovative projects in the presence of adverse-selection based financing constraints. Government programmes allocating direct subsidies are based on ex-ante screening of the subsidy applications. This selection scheme may yield valuable information to market-based financiers. We find that under certain conditions, public R&D subsidies can reduce the financing constraints of technology-based entrepreneurial firms. Firstly, the subsidy itself reduces the capital costs related to innovation projects by reducing the amount of market-based capital required. Secondly, the observation that an entrepreneur has received a subsidy for an innovation project provides an informative signal to market-based financiers. We also find that public screening works more efficiently if it is accompanied by subsidy allocation.
Keywords: adverse selection, innovation finance, financial constraints, R&D subsidies, certification
JEL Classification: D82, G28, H20, O30, O38
Suggested Citation: Suggested Citation
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