Information asymmetry, risk aversion and R&D subsidies: Effect-size heterogeneity and policy conundrums

Drawing on the theory of contracts and Schumpeterian models of innovation, we argue that direct public support for business R&D may deliver sub-optimal outcomes if firms are risk-averse and have private information about their R&D productivity. Using observable proxies for risk aversion and R&D productivity, we report that the average treatment effect (ATT) in the sample of sample of 43,650 British firms is positive but highly heterogenous. The ATTs tend to be: (a) insignificant or negligible when the perceived risk of R&D investment is high due to crisis episodes or because of investment in basic research; (b) insignificant among larger and older firms and firms closer to the R&D frontier; and (c) positive and larger than the average among small and young firms and firms further away from the R&D frontier. Our findings point out to conundrums in the use of R&D subsidies as an innovation policy tool: The case for R&D subsidies is stronger during economic downturns, when the investment is in basic R&D and when firms have a higher probability of innovation success; but the subsidy is less likely to increase business R&D under these conditions.