DP12199 Government Financing of R&D: A Mechanism Design Approach

Author(s): Saul Lach, Zvika Neeman, Mark Schankerman
Publication Date: August 2017
Keyword(s): additionality, entrepreneurship, government nance, innovation, mechanism design, R&D, start-ups
JEL(s): D61, D82, O32, O38
Programme Areas: Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=12199

We study the design of a government loan program for risky R&D projects that generate positive externalities, undertaken by entrepreneurs in a competitive capital market environment. With adverse selection, the optimal contract requires a high interest rate but nearly zero co-financing by the entrepreneur. This contrasts sharply with observed policies, typified by a low interest rate and high co-finanacing requirement. When we add moral hazard (endogenous success), the optimal policy consists of a menu of at most two contracts, one with high interest/zero self-finanacing and a second with a lower interest but also a co-finanacing requirement. Calibrated simulations compare the optimal policy and observed program designs in terms of innovation and welfare.