DP12199 Government Financing of R&D: A Mechanism Design Approach
Author(s): | Saul Lach, Zvika Neeman, Mark Schankerman |
Publication Date: | August 2017 |
Date Revised: | March 2020 |
Keyword(s): | additionality, entrepreneurship, government finance, Innovation, mechanism design, R&D, start-ups |
JEL(s): | D61, D82, O32, O38 |
Programme Areas: | Industrial Organization |
Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=12199 |
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.