Government financing of R&D: A mechanism design approach
Saul Lach, Zvika Neeman and Mark Schankerman
Published 26 August 2020
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 private venture capital firms. The gains vary with the size of the externalities, cost of public funds, and effectiveness of the private VC industry.
Paper Number EI 55:
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JEL Classification: D61; D82; O32; O38