Central European Journal of Operations Research

, Volume 25, Issue 4, pp 743–770 | Cite as

State subsidy and moral hazard in corporate financing

  • Edina Berlinger
  • Anita Lovas
  • Péter Juhász
Original Paper


This paper investigates the impact of state subsidy on the behavior of the entrepreneur under asymmetric information. Several authors formulated concerns about state intervention as it can aggravate moral hazard in corporate financing. In the seminal paper of Holmström and Tirole (Q J Econ 112(3):663–691, 1997) a two-player moral hazard model is presented with an entrepreneur initiating a risky scalable project and a private investor (e.g. bank or venture capitalist) providing outside financing. The novelty of our research is that this basic moral hazard model is extended to the case of positive externalities and to three players by introducing the state subsidizing the project. It is shown that in the optimum, state subsidy does not harm, but improves the incentives of the entrepreneur to make efforts for the success of the project; hence in effect state intervention reduces moral hazard. Consequently, state subsidy increases social welfare which is defined as the sum of private and public net benefits. Also, the exact form of the state subsidy (ex-ante/ex-post, conditional/unconditional, refundable/nonrefundable) is irrelevant in respect of the optimal size and the total welfare effect of the project. Moreover, in case of nonrefundable subsidies state does not crowd out private investors; but on the contrary, by providing additional capital it boosts private financing. These results are mainly due to the special mechanism imbedded in our model by which the private investor is able to transform even the badly designed state subsidies into a success fee which is optimal from the incentive point of view.


Contract theory Externalities Asymmetric information Crowding out 

JEL Classification

D28 D86 G38 H23 H81 



This paper was supported by the János Bolyai Research Scholarship of the Hungarian Academy of Sciences, by the Momentum Programme (LP-004/2010), by the research grant of the Corvinus Business School, and by Pallas Athene Domus Scientiae Foundation. The views expressed are those of the authors and do not necessarily reflect the official opinion of the supporters.


  1. Berlinger E, Lovas A, Juhász P (2015a) The impact of state subsidy on project financing under moral hazard and positive externalities. Econ Rev 62(2):139–171 (in Hungarian)Google Scholar
  2. Berlinger E, Lovas A, Juhász P (2015b) State subsidy and moral hazard in corporate financing. Working Paper, Corvinus University of Budapest Faculty of EconomicsGoogle Scholar
  3. Biagi F, Bondonio D, Martini A (2015) Counterfactual impact evaluation of enterprise support programmes. In: Evidence from a decade of subsidies to Italian firm, 55th congress of the European regional science association: “World Renaissance: changing roles for people and places”, 25–28 August 2015, Lisbon, Portugal.
  4. Bondonio D, Greenbaum RT (2010) Counterfactual impact evaluation of enterprise support policies: an empirical application to EU co-sponsored, national and regional programs. John Glenn School of Public Affairs Working Paper Series, July 2010. Accessed 5 Aug 2014
  5. Borisova G, Fotak V, Holland K, Megginson W (2015) Government ownership and the cost of debt: evidence from government investments in publicly traded firms. J Financ Econ 118:168–191CrossRefGoogle Scholar
  6. Breska EV (ed) (2010) Investing in Europe’s future. Fifth report on economic, social and territorial cohesion. European Commission, November 2010. Accessed 4 Aug 2014
  7. Bronzini R, Piselli P (2016) The impact of R&D subsidies on firm innovation. Res Policy 45:442–457. Available from: ScienceDirect, Ipswich, MA. Accessed 19 Dec 2015Google Scholar
  8. Chaney PK, Thakor AV (1985) Incentive effects of benevolent intervention: the case of government loan guarantees. J Public Econ 26:169–189CrossRefGoogle Scholar
  9. Csóka P, Havran D, Szűcs N (2015) Corporate financing under moral hazard and the default risk of buyers. Cent Eur J Oper Res 23(4):763–778CrossRefGoogle Scholar
  10. Cull R, Xu LC, Yang X, Zhou L, Zhu T (2015) Market facilitation by local government and firm efficiency: evidence from China. J Corp Finance. doi: 10.1016/j.jcorpfin.2015.06.002
  11. Czarnitzki D, Lopes-Bento C (2013) Value for money? New microeconometric evidence on public R&D grants in Flanders. Res Policy 42(1):76–89CrossRefGoogle Scholar
  12. Garcia A, Mohnen P (2010) Impact of government support on R&D and innovation. MERIT working papers 034, United Nations University—Maastricht Economic and Social Research Institute on Innovation and Technology (MERIT)Google Scholar
  13. Girma S, Görg H, Strobl E (2007) The effect of government grants on plant level productivity. Econ Lett 94(3):439–444CrossRefGoogle Scholar
  14. González X, Pazó C (2008) Do public subsidies stimulate private R&D spending? Res Policy 37(3):371–389CrossRefGoogle Scholar
  15. Grossman SJ, Hart OD (1983) An analysis of the principal–agent problem. Econometrica 51(1):7–45CrossRefGoogle Scholar
  16. Hart OD, Moore J (1998) Default and renegotiation: a dynamic model of debt. Q J Econ 113(1):1–41CrossRefGoogle Scholar
  17. Hirsch J (2006) Public policy and venture capital financed innovation: a contract design approach. CFS working paper, No. 2006/29 (December)Google Scholar
  18. Holmström B, Tirole J (1997) Financial intermediation, loanable funds, and the real sector. Q J Econ 112(3):663–691CrossRefGoogle Scholar
  19. Hong J, Hong S, Wang L, Xu Y, Zhao D (2015) Government grants, private R&D funding and innovation efficiency in transition economy. Technol Anal Strateg Manag 27(9):1068–1096CrossRefGoogle Scholar
  20. Huergo E, Moreno L (2014) National or international public funding? Subsidies or loans? Evaluating the innovation impact of R&D support programmes. MPRA paper 64926, University Library of Munich, GermanyGoogle Scholar
  21. Huergo E, Trenado M, Ubierna A (2015) The impact of public support on firm propensity to engage in R&D: Spanish experience. Technological Forecasting & Social Change. Available online 23 May 2015Google Scholar
  22. Kállay L (2014) State subsidies and economic performance. Econ Rev 61(3):279–298 (in Hungarian)Google Scholar
  23. Keuschnigg C, Nielsen SB (2001) Public policy for venture capital. Int Tax Public Finance 8:557–572CrossRefGoogle Scholar
  24. Kleer R (2010) Government R&D subsidies as a signal for private investors. Res Policy 39(10):1361–1374CrossRefGoogle Scholar
  25. Kotowitz Y (2008) Moral hazard. In: Durlauf Steven N, Blume Lawrence E (eds) The new Palgrave dictionary of economics. Palgrave Macmillan, New YorkGoogle Scholar
  26. Laffont J-J, Tirole J (1988) The dynamics of incentive contracts. Econometrica 56(5):1153–1175CrossRefGoogle Scholar
  27. Luukkonen T, Deschryvere M, Bertoni F (2013) The value added by government venture capital funds compared with independent venture capital funds. Technovation 33:154–162CrossRefGoogle Scholar
  28. Meuleman M, De Maeseneire W (2012) Do R&D subsidies affect SMEs’ access to external financing? Res Policy 41(3):580–591CrossRefGoogle Scholar
  29. Mouqué D (2012) What are counterfactual impact evaluations teaching us about enterprise and innovation support? European Commission, Regional Focus, December 2012, no. 2. Accessed 4 Aug 2014
  30. Sappington D (1983) Limited liability contracts between principal and agent. J Econ Theory 29(1):1–21CrossRefGoogle Scholar
  31. Schertler A (2000) The impact of public subsidies on venture capital investments in start-up enterprises. Kiel working papers, no. 1018. Kiel Institute for the World Economy, GermanyGoogle Scholar
  32. Schertler A (2002a) Venture capitals investments incentives under public equity schemes. Kiel working papers, no. 1117. Kiel Institute for the World Economy, GermanyGoogle Scholar
  33. Schertler A (2002b) Comparative advantages of public loan and public equity schemes in venture capital markets. Kiel working papers, no. 1118. Kiel Institute for the World Economy, GermanyGoogle Scholar
  34. Shavell S (1979) Risk sharing and incentives in the principal and agent relationship. Bell J Econ 10(1):55–73CrossRefGoogle Scholar
  35. Simachev Y, Kuzyk M, Feygina V (2015) Public support for innovation in Russian firms: looking for improvements in corporate performance quality. Int Adv Econ Res 21:13–31CrossRefGoogle Scholar
  36. Stiglitz JE, Greenwald BC (2014) Creating a learning society. Columbia University Press, New YorkCrossRefGoogle Scholar
  37. Takalo T, Tanayama T (2010) Adverse selection and financing of innovation: is there a need for R&D subsidies? J Technol Transf 35(1):16–41CrossRefGoogle Scholar
  38. Tirole J (2006) The theory of corporate finance. Princeton University Press, PrincetonGoogle Scholar
  39. Walter Gy (2014) State subsidies. In: Walter Gy (ed) Corporate financing in practice. Alinea Publishing, Copenhagen, pp 211–224 (in Hungarian)Google Scholar
  40. Widerstedt B, Månsson J (2015) Can business counselling help SMEs grow? Evidence from the Swedish business development grant programme. J Small Bus Enterp Dev 22(4):652–665CrossRefGoogle Scholar
  41. Zheng Y, Zhu Y (2013) Bank lending incentives and firm investment decisions in China. J Multinatl Financ Manag 23(Special Issue on Financial Management in China):146–165CrossRefGoogle Scholar

Copyright information

© Springer-Verlag Berlin Heidelberg 2016

Authors and Affiliations

  1. 1.Department of FinanceCorvinus University of BudapestBudapestHungary

Personalised recommendations