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Adverse selection and financing of innovation: is there a need for R&D subsidies?

Tuomas Takalo and Tanja Tanayama

No 19/2008, Bank of Finland Research Discussion Papers from Bank of Finland

Abstract: We study the interaction between private and public funding of innovative projects in the presence of adverse-selection based financing constraints. Government programmes 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. Firstly, the subsidy itself reduces the capital costs related to innovation projects by reducing the amount of market-based capital required. Secondly, the observation that an entrepreneur has received a subsidy for an innovation project provides an informative signal to market-based financiers. We also find that public screening works more efficiently if it is accompanied by subsidy allocation.

Keywords: adverse selection; innovation finance; financial constraints; R&D subsidies; certification (search for similar items in EconPapers)
JEL-codes: D82 G28 H20 O30 O38 (search for similar items in EconPapers)
Date: 2008
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