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How to Motivate Fundamental Innovation: Subsidies versus Prizes and the Role of Venture Capital

Author

Listed:
  • Onur Bayar

    (UTSA)

  • Thomas J. Chemmanur
  • Mark H. Liu

Abstract

In this paper, we analyze the mechanisms through which governments and non-profit agencies (principals) may incentivize the development of fundamental innovations, defined as those innovations that have positive social value net of development costs, but have negative net present values to the innovating firms due to the limited appropriability of their value by such firms. We solve for the principal’s optimal choice between subsidy schemes and incentivizing prizes under two alternative assumptions: first, where the producing firms’ innovation development costs are observable by the principal; and second, where such costs are unobservable. We then introduce venture capitalists (VCs) into the above setting and analyze how VCs may enhance the efficiency of the principal in motivating fundamental innovations. Our analysis has several implications for how to better incentivize innovation development, and in particular, for how government-funded venture capitalists may enhance innovation.

Suggested Citation

  • Onur Bayar & Thomas J. Chemmanur & Mark H. Liu, "undated". "How to Motivate Fundamental Innovation: Subsidies versus Prizes and the Role of Venture Capital," Working Papers 0175fin, College of Business, University of Texas at San Antonio, revised 06 Jan 2016.
  • Handle: RePEc:tsa:wpaper:0175fin
    as

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    File URL: http://interim.business.utsa.edu/wps/FIN/0009FIN-567-2015.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Financing of Innovations; Fundamental Innovation; Subsidies; Prizes; Venture Capital;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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