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How to select Instruments supporting R&D and Innovation by Industry

Listed author(s):
  • Marcel J.L. de Heide

    (Erasmus University Rotterdam)

  • Amit Kothiyal

    (Erasmus University Rotterdam)

Registered author(s):

    We present a theoretical framework which allows for the comparison of the effectiveness of tax measures, loans and funding, in supporting industry-oriented research. We estimate for each of the instruments the exact contribution required by a firm to decide on investing in R&D, given the costs and probability of success of the project, and the foreseen change in profit following successful implementation of the research results. We apply Prospect Theory to analyse the risk attitude of the firm. By comparing the contribution required, we identify the instrument which is most effective, and therefore preferred by a government. Our analysis indicates that there exists a critical value for the probability of success of the project for which the modality of the most effective instruments changes. For a probability of success smaller than the critical value, a tax measures offering support only in case of successful completion of the project is preferred. For a probability higher than the critical value, a loan is most effective. The value of the critical probability depends on the perception of risk and loss aversion of the firm involved in the research.

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    File URL: http://papers.tinbergen.nl/11021.pdf
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    Paper provided by Tinbergen Institute in its series Tinbergen Institute Discussion Papers with number 11-021/2.

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    Date of creation: 03 Feb 2011
    Date of revision: 07 Feb 2011
    Handle: RePEc:tin:wpaper:20110021
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    1. Kenneth Arrow, 1962. "Economic Welfare and the Allocation of Resources for Invention," NBER Chapters,in: The Rate and Direction of Inventive Activity: Economic and Social Factors, pages 609-626 National Bureau of Economic Research, Inc.
    2. Han Bleichrodt & Jose Luis Pinto & Peter P. Wakker, 2001. "Making Descriptive Use of Prospect Theory to Improve the Prescriptive Use of Expected Utility," Management Science, INFORMS, vol. 47(11), pages 1498-1514, November.
    3. Eren Inci, 2009. "R&D tax incentives: a reappraisal," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 16(6), pages 797-821, December.
    4. Richard R. Nelson, 1959. "The Simple Economics of Basic Scientific Research," Journal of Political Economy, University of Chicago Press, vol. 67, pages 297-297.
    5. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
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