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 cofinancing by the entrepreneur. This contrasts sharply with observed loan schemes. With adverse selection and moral hazard, allowing for two levels of effort by the entrepreneur, 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 cofinancing. 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, the cost of public funds, and the effectiveness of the private venture capital industry.
Lach, Saul, Zvika Neeman, and Mark Schankerman.
"Government Financing of R&D: A Mechanism Design Approach."
American Economic Journal: Microeconomics,
Asymmetric and Private Information; Mechanism Design
Economics of Contract: Theory
Investment Banking; Venture Capital; Brokerage; Ratings and Ratings Agencies
Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts
Innovation and Invention: Processes and Incentives