Adverse selection and financing of innovation: is there a need for R&D subsidies?
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- Takalo, T. & Tanayama, T. J Technol Transf (2010) 35: 16. doi:10.1007/s10961-009-9112-8
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We study the interaction of private and public funding of innovative projects in the presence of adverse-selection based financing constraints. Government programs 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. First, the subsidy itself reduces the capital costs related to the innovation projects by reducing the amount of market-based capital required. Second, the observation that an entrepreneur has received a subsidy for an innovation project provides an informative signal to the market-based financiers. We also find that public screening works more efficiently if it is accompanied with subsidy allocation.