The Financing of Innovative Activities by Banking Institutions: Policy Issues and Regulatory Options

Elisa Ughetto
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Elisa Ughetto: Politecnico di Torino

Chapter 13 in Powerful Finance and Innovation Trends in a High-Risk Economy, 2008, pp 224-247 from Palgrave Macmillan

Abstract: Abstract It is a widely held view that firms characterized by high levels of research and development (R&D) spending are very likely to undergo financial constraints. This line of reasoning was originally addressed by two influential papers by Nelson (1959) and Arrow (1962), which pointed to the incomplete appropriability of the returns to R&D as the potential source of the limited private incentives to the allocation of financial resources to basic and applied research. The argument of market failure for R&D investments was later investigated by many researchers in economics and finance (see Hall, 2002 for a review). A common theoretical framework to these studies is that they mostly explain credit rationing or the extension of credit only on unfavourable terms to innovative firms with the presence of information asymmetries between lenders and borrowers. Generally entrepreneurs are better informed than lenders as to the likelihood of success for their innovation projects, and they usually have little incentive to disclose information to investors since this might reveal useful information to competitors (Carpenter and Petersen, 2002; Bhattacharya and Ritter, 1983). Thus investors have more difficulty in distinguishing good projects from bad ones, making credit rationing more probable Qaffee and Russell, 1976; Stiglitz and Weiss, 1981). Also moral hazard problems can hamper the external financing of innovative investments since entrepreneurs could change ex-post their behaviour by replacing low-risk low-return projects with high-risk high-return ones (Hall, 2002; Carpenter and Petersen, 2002).

Keywords: Credit Risk; Innovative Activity; Innovative Firm; Banking Institution; Basel Committee (search for similar items in EconPapers)
Date: 2008
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DOI: 10.1057/9780230584099_14

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