How does the state destroy incentives in innovation financing?

Edina Berlinger

Corvinus Economics Working Papers (CEWP) from Corvinus University of Budapest

Abstract: We investigate the effect of state subsidy on the behavior of entrepreneur and venture capitalist in a double moral hazard and fixed investment model under positive externalities. We infer that investment subsidy and success fee improve the incentives, ease credit rationing, hence boost private financing, which explains the popularity of hybrid venture capital systems. The main disadvantage of these systems is, however, that the entrepreneur is encouraged to minimize his/her own capital investment and to ask for the maximal state subsidy available. It may happen that public sources go to entrepreneurs capable to finance their projects privately, so state subsidies increase state deficit (and private profits) without any effects on public welfare leaving other important areas underfinanced. We also prove that state guarantee definitely creates perverse incentives, hence it is not recommended in our model.

Keywords: innovation financing; venture capital; state subsidy; moral hazard (search for similar items in EconPapers)
JEL-codes: D21 G38 H32 H50 O38 (search for similar items in EconPapers)
Date: 2018-09
New Economics Papers: this item is included in nep-cfn, nep-ent, nep-ino and nep-ppm
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Persistent link: https://EconPapers.repec.org/RePEc:cvh:coecwp:2018/02

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