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How does the state destroy incentives in innovation financing?

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  • Berlinger, Edina

Abstract

We investigate the effect of state subsidy on the behavior of entrepreneur and venture capitalist in a double moral hazard and fixed investment model under positive externalities. We infer that investment subsidy and success fee improve the incentives, ease credit rationing, hence boost private financing, which explains the popularity of hybrid venture capital systems. The main disadvantage of these systems is, however, that the entrepreneur is encouraged to minimize his/her own capital investment and to ask for the maximal state subsidy available. It may happen that public sources go to entrepreneurs capable to finance their projects privately, so state subsidies increase state deficit (and private profits) without any effects on public welfare leaving other important areas underfinanced. We also prove that state guarantee definitely creates perverse incentives, hence it is not recommended in our model.

Suggested Citation

  • Berlinger, Edina, 2018. "How does the state destroy incentives in innovation financing?," Corvinus Economics Working Papers (CEWP) 2018/02, Corvinus University of Budapest.
    • Handle: RePEc:cvh:coecwp:2018/02
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    File URL: https://unipub.lib.uni-corvinus.hu/3711/
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    Keywords

    innovation financing; venture capital; state subsidy; moral hazard;
    All these keywords.

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation
    • H32 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Firm
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General
    • O38 - Economic Development, Innovation, Technological Change, and Growth - - Innovation; Research and Development; Technological Change; Intellectual Property Rights - - - Government Policy

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