2008
19/2008
Adverse selection and financing of innovation: is there a need for R&D subsidies?
Author(s): Tuomas Takalo – Tanja Tanayama
2008. 41 pages.
Publisher: Bank of Finland
ISBN 978-952-462-454-1 (Printed publication)
ISBN 978-952-462-455-8 (Web publication)
Search words: adverse selection, innovation finance, financial constraints, R&D subsidies, certification, D82, G28, H20, O30, O38, Tuomas Takalo, Tanja Tanayama
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.