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State subsidy and moral hazard in corporate financing

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  • Berlinger, Edina
  • Lovas, Anita
  • Juhász, Péter

Abstract

This paper investigates the impact of state subsidy on the behavior of the entrepreneur under asymmetric information. Several authors formulated concerns about state intervention as it can aggravate moral hazard in corporate financing. In the seminal paper of Holmström and Tirole (1997) a two-player moral hazard model is presented with an entrepreneur initiating a risky scalable project and a private investor (e.g. bank or venture capitalist) providing outside financing. The novelty of our research is that this basic moral hazard model is extended to the case of positive externalities and to three players by introducing the state subsidizing the project. It is shown that in the optimum, state subsidy does not harm, but improves the incentives of the entrepreneur to make efforts for the success of the project; hence in effect state intervention reduces moral hazard. Consequently, state subsidy increases social welfare which is defined as the sum of private and public net benefits. Also, the exact form of the state subsidy (ex-ante/ex-post, conditional/unconditional, refundable/nonrefundable) is irrelevant in respect of the optimal size and the total welfare effect of the project. Moreover, in case of nonrefundable subsidies state does not crowd out private investors; but on the contrary, by providing additional capital it boosts private financing. In case of refundable subsidies some crowding effects may occur depending on the subsidy form and the parameters.

Suggested Citation

  • Berlinger, Edina & Lovas, Anita & Juhász, Péter, 2015. "State subsidy and moral hazard in corporate financing," Corvinus Economics Working Papers (CEWP) 2015/22, Corvinus University of Budapest.
  • Handle: RePEc:cvh:coecwp:2015/22
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    Cited by:

    1. Edina Berlinger & Anita Lovas & Péter Juhász, 2017. "State subsidy and moral hazard in corporate financing," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 25(4), pages 743-770, December.
    2. Tibor Csendes & Csanád Imreh & József Temesi, 2017. "Editorial," Central European Journal of Operations Research, Springer;Slovak Society for Operations Research;Hungarian Operational Research Society;Czech Society for Operations Research;Österr. Gesellschaft für Operations Research (ÖGOR);Slovenian Society Informatika - Section for Operational Research;Croatian Operational Research Society, vol. 25(4), pages 739-741, December.
    3. Hussain, Jafar & Lee, Chien-Chiang & Chen, Yongxiu, 2022. "Optimal green technology investment and emission reduction in emissions generating companies under the support of green bond and subsidy," Technological Forecasting and Social Change, Elsevier, vol. 183(C).
    4. Gyorgy Vas, 2017. "The Moral Hazard issues of the State-Aid Programs for SME’s," Proceedings- 11th International Conference on Mangement, Enterprise and Benchmarking (MEB 2017),, Óbuda University, Keleti Faculty of Business and Management.
    5. Banai, Ádám & Lang, Péter & Nagy, Gábor & Stancsics, Martin, 2020. "Waste of money or growth opportunity: The causal effect of EU subsidies on Hungarian SMEs," Economic Systems, Elsevier, vol. 44(1).

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    More about this item

    Keywords

    contract theory; externalities; asymmetric information; crowding out;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts

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