Adverse Selection and Financing of Innovation: Is There a Need for R&D Subsidies?

44 Pages Posted: 1 Jan 2009

See all articles by Tuomas Takalo

Tuomas Takalo

Bank of Finland

Tanja Tanayama

Government of the Republic of Finland - National Audit Office of Finland

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

Takalo, Tuomas and Tanayama, Tanja, Adverse Selection and Financing of Innovation: Is There a Need for R&D Subsidies? (September 12, 2008). Bank of Finland Research Discussion Paper No. 19/2008, Available at SSRN: https://ssrn.com/abstract=1268314 or http://dx.doi.org/10.2139/ssrn.1268314

Tuomas Takalo (Contact Author)

Bank of Finland ( email )

P.O. Box 160
Helsinki 00101
Finland

Tanja Tanayama

Government of the Republic of Finland - National Audit Office of Finland ( email )

Antinkatu 1
P.O. Box 1119
Helsinki, FIN-00101
Finland

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