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Government Financing of R&D: A Mechanism Design Approach

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  • Schankerman, Mark
  • Lach, Saul
  • Neeman, Zvika

Abstract

We study how to design an optimal government loan program for risky R&D projects with positive externalities. With adverse selection, the optimal government contract involves a high interest rate but nearly zero co-financing by the entrepreneur. This contrasts sharply with observed loan schemes. With adverse selection and moral hazard (two effort levels), the optimal policy consists of a menu of at most two contracts, one with high interest and zero self-financing, and a second with a lower interest plus co-financing. Calibrated simulations assess welfare gains from the optimal policy, observed loan programs, and a direct subsidy to the private venture capital market. The gains vary with the size of the externalities, cost of public funds, and effectiveness of the private VC industry.

Suggested Citation

  • Schankerman, Mark & Lach, Saul & Neeman, Zvika, 2017. "Government Financing of R&D: A Mechanism Design Approach," CEPR Discussion Papers 12199, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:12199
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    Cited by:

    1. Gehrig, Thomas & Stenbacka, Rune, 2023. "R&D and subsidy policy with imperfect project classification," Economics Letters, Elsevier, vol. 222(C).
    2. Maria Garcia-Vega & Oscar Vicente-Chirivella, 2019. "R&D and firm resilience during bad times," Discussion Papers 2019-13, University of Nottingham, GEP.
    3. Isabel Busom & Jorge-Andrés Vélez-Ospina, 2021. "Subsidising innovation over the business cycle," Industry and Innovation, Taylor & Francis Journals, vol. 28(6), pages 773-803, July.
    4. Ahlvik, Lassi & van den Bijgaart, Inge, 2024. "Screening green innovation through carbon pricing," Journal of Environmental Economics and Management, Elsevier, vol. 124(C).
    5. García-Vega, María & Vicente-Chirivella, Óscar, 2020. "Do university technology transfers increase firms’ innovation?," European Economic Review, Elsevier, vol. 123(C).
    6. Rainer Widmann, 2023. "The Behavioral Additionality of Government Research Grants," Rationality and Competition Discussion Paper Series 417, CRC TRR 190 Rationality and Competition.
    7. Eduardo FERNANDEZ-ARIAS & Jiajun XU, 2020. "Effective development banking: loans or guarantees?," Working Paper 2fcdfcfb-d113-44d8-9e02-6, Agence française de développement.
    8. Eduardo FERNANDEZ-ARIAS & Jiajun XU, 2020. "Effective development banking: loans or guarantees?," Working Paper 2fcdfcfb-d113-44d8-9e02-6, Agence française de développement.
    9. Widmann, Rainer, 2024. "The behavioral additionality of government research grants," International Journal of Industrial Organization, Elsevier, vol. 93(C).

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    More about this item

    Keywords

    Mechanism design; Innovation; R&d; Start-ups; entrepreneurship; Additionality; Government finance;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • O32 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Management of Technological Innovation and R&D
    • O38 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Government Policy

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