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The Economics of State Subsidies in Early Stage Financing

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  • Ekkehardt Bauer
  • Hans-Peter Burghof

Abstract

We analyze the effect of state subsidies on early stage investments. In a two-period investment model with incomplete stage financing contracts, we describe optimal and second-best investment levels. Optimality depends on external effects: given that private early stage financing generates positive external effects, the subsidies might be designed to use scarce state money most efficiently to mobilize private investment capital. However, a subsidy might also contribute to greater efficiency of the contractual relationship itself without regard to external effects. Refinancing subsidies can be optimal under both perspectives and are always optimal under last of the two approaches. The comparison of the main types of subsidies, i.e. refinancing subsidies, guarantees and direct investments, speaks against the use of guarantees. Finally, we show that our results do also hold if some investors (e.g. venture capitalists) have a superior screening capability.

Suggested Citation

  • Ekkehardt Bauer & Hans-Peter Burghof, 2007. "The Economics of State Subsidies in Early Stage Financing," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 14(3), pages 433-457.
    • Handle: RePEc:taf:ijecbs:v:14:y:2007:i:3:p:433-457
    DOI: 10.1080/13571510701597353
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    References listed on IDEAS

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    1. Douglas Cumming & Sofia Johan, 2007. "Advice and monitoring in venture finance," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 21(1), pages 3-43, March.
    2. Bascha, Andreas & Walz, Uwe, 2002. "Financing practices in the German venture capital industry: An empirical assessment," CFS Working Paper Series 2002/08, Center for Financial Studies (CFS).
    3. Schertler, Andrea, 2002. "Path dependencies in venture capital markets," Kiel Working Papers 1120, Kiel Institute for the World Economy (IfW Kiel).
    4. Jenkinson, Tim & Ljungqvist, Alexander, 2001. "Going Public: The Theory and Evidence on How Companies Raise Equity Finance," OUP Catalogue, Oxford University Press, edition 2, number 9780198295990.
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    1. Gunther Schnabl & Georg Fahrenschon & Markus Demary & Judith Niehues & Olaf Stotz & Hans-Peter Burghof, 2016. "Causes and Consequences of Low Interest Rates: Are Savers Are Being Expropriated?," ifo Schnelldienst, ifo Institute - Leibniz Institute for Economic Research at the University of Munich, vol. 69(13), pages 03-18, July.

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