Business Taxation and Venture-Capital-Financed Innovation

Jean-François Tremblay

FinanzArchiv: Public Finance Analysis, 2009, vol. 65, issue 2, 141-161

Abstract: This paper examines a model of sequential cost-saving innovations financed by venture capital. Successful firms in research can enter the market with a cost advantage over older firms and acquire market power. Innovators have the technical knowledge to conduct R&D but lack the necessary financial resources. Their projects are financed by venture capitalists in exchange for a share of future profits. Venture capitalists can also provide advice and support to innovators, which increases the likelihood of success. Moral hazard between innovators and venture capitalists and rent-seeking behavior introduce various distortions in the level of effort provided by venture capitalists, the size of innovations, and the timing of R&D activities. The system of taxes and subsidies on R&D expenditures, capital gains, and capital investment required to induce the social optimum is characterized. Surprisingly, such a tax system must increase the cost of R&D and lower the return to capital.

Keywords: sequential innovation; venture capital; moral hazard (search for similar items in EconPapers)
JEL-codes: G24 H21 H25 O31 (search for similar items in EconPapers)
Date: 2009
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DOI: 10.1628/001522109X466545

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