Adverse selection and financing of innovation: is there a need for R&D subsidies?

We study the interaction between private and public funding of innovative projects in the presence of adverse-selection based financing constraints. Government programmes allocating direct subsidies are based on ex-ante screening of the subsidy applications. This selection scheme may yield valuable information to market-based financiers. We find that under certain conditions, public R&D subsidies can reduce the financing constraints of technology-based entrepreneurial firms. Firstly, the subsidy itself reduces the capital costs related to innovation projects by reducing the amount of market-based capital required. Secondly, the observation that an entrepreneur has received a subsidy for an innovation project provides an informative signal to market-based financiers. We also find that public screening works more efficiently if it is accompanied by subsidy allocation.adverse selection; innovation finance; financial constraints; R&D subsidies; certification

SELECTION OR SELF-REJECTION? APPLICATIONS INTO A TREATMENT

We develop a new method to estimate the returns to R&D, their distribution, and their determinants. We model a continuous optimal treatment with outcome heterogeneity, where the treatment outcome depends on the applicant’s investment. The model takes into account application costs, and isolates the effects of the treatment on the public agency running the treatment program. Under the assumption of a welfare-maximizing agency, we identify general equilibrium treatment effects and social returns to R&D. The model yields a restriction on the application equation that helps identify the parameters of the cost-of- application function. The proposed estimation strategy is applied to project level data from the granting process of R&D subsidies. We find that larger firms have higher marginal profitability of R&D. Rates of return on R&D are high and their distribution skew. Agency specific returns are non-monotonic in private returns. Project level spillovers are linear in R&D. The median increase from subsidies in the agency’s utility not appropriated by the applicant is 16 000€. Application costs increase with the profitability shock and ignoring application costs severely biases the estimated rates of return upwards.applications, effort, investment, rate of return, R&D, R&D return distribution selection, subsidies, treatment program, treatment effects, welfare

Evaluating innovation policy: a structural treatment effect model of R&D subsidies

This paper studies the welfare effects of R&D subsidies. We develop a model of continuous optimal treatment with outcome heterogeneity where the treatment outcome depends on applicant investment. The model takes into account heterogeneous application costs and identifies the treatment effect on the public agency running the programme. Under the assumption of a welfare-maximizing agency, we identify general equilibrium treatment effects. Applyiing our model to R&D project-level data we find substantial treatment effect heterogeneity. Agency-specific treatment effects are smaller than private treatment effects. We find that the rate of return on subsidies for the agency is 30–50%.applications; effort; investment; R&D; selection; subsidies; treatment programme; treatment effects; welfare

Erityyppisten innovaatioiden taustalla olevat kehitysprosessit

Only abstract. Paper copies of master’s theses are listed in the Helka database (http://www.helsinki.fi/helka). Electronic copies of master’s theses are either available as open access or only on thesis terminals in the Helsinki University Library.Vain tiivistelmä. Sidottujen gradujen saatavuuden voit tarkistaa Helka-tietokannasta (http://www.helsinki.fi/helka). Digitaaliset gradut voivat olla luettavissa avoimesti verkossa tai rajoitetusti kirjaston opinnäytekioskeilla.Endast sammandrag. Inbundna avhandlingar kan sökas i Helka-databasen (http://www.helsinki.fi/helka). Elektroniska kopior av avhandlingar finns antingen öppet på nätet eller endast tillgängliga i bibliotekets avhandlingsterminaler.Tutkimuksessa tarkasteltiin, miten teknologiselta luonteeltaan erityyppisten innovaatioiden kehittämisprosessit poikkeavat toisistaan. Innovaation teknologista luonnetta kuvattiin kahdesta eri näkökulmasta. Ensinnäkin innovaatiot jaettiin niiden uutusarvon mukaan radikaaleihin ja inkrementaalisiin innovaatioi-hin. Tämän lisäksi innovaatiot eroteltiin niiden kompleksisuuden mukaan monimutkaisiin ja yksinkertaisiin innovaatioihin. Probit-malleja soveltamalla tutkittiin, minkälaisia systemaattisia eroja on radikaalien innovaatioiden kehittämisprosessissa verrattuna inkrementaalisten innovaatioiden kehittämiseen sekä monimutkaisten innovaatioiden kehittämisprosessissa verrattuna yksinkertaisten innovaatioiden kehittämiseen. Tutkimuksen teoreettisena viitekehyksenä oli eri innovaatioteorioita käsittelevä kirjallisuus. Tutkimuksessa tarkastellut kehitysprosessiin liittyvät tekijät voidaan jakaa innovaatiokohtaisiin- ja yritys- tai sektorikohtaisiin tekijöihin. Innovaatiokohtaiset tekijät liittyvät siihen, mistä innovaatioidea on alunperin lähtöisin, minkälainen yhteistyö on ollut tärkeää innovaation kehittämiselle sekä minkälainen rooli julkisella rahoituksella on ollut innovaation kehittämisessä. Yritys- ja sektorikohtaiset tekijät puolestaan liittyvät innovaation kehittäneen yrityksen osaamispohjaan, kokoon sekä yrityksen toimintaympäristöön. Tutkimus perustui VTT Teknologian tutkimuksen ryhmän keräämään innovaatioaineistoon. Innovaatio-aineisto sisältää perustiedot noin 1600 Suomessa kehitetystä innovaatiosta, jotka on kaupallistettu pääosin 1980- ja 90-luvuilla. Tätä perustietokantaa on täydennetty noin 800 innovaatiota käsittävällä kyselyaineistolla, joka sisältää yksityiskohtaista tietoa kunkin innovaation kehitysprosessista. Tutkimuksessa käytettiin 768 innovaation joukkoa tästä kyselyaineistosta, johon yhdistettiin yrityskohtaisia tietoja. Tuloksissa nousi esille tiede- ja teknologiayhteisön merkitys, kun kehitetään radikaaleja tai monimutkaisia innovaatioita. Tieteellisten ja teknologisten läpimurtojen merkitys sekä yhteistyö yliopistojen ja korkeakoulujen kanssa korostuivat sekä radikaalien että monimutkaisten innovaatioiden kehittämisessä. Sen sijaan pääosin kilpailullisista paineista syntyneet innovaatiot olivat todennäköisemmin inkrementaalisia. Radikaalien ja monimutkaisten innovaatioiden taustalta erottuivat myös julkiset tuotekehitystuet. Toimintaympäristö, jossa innovaatio on kehitetty näyttäisi omalta osaltaan vaikuttavan innovaation teknologiseen luonteeseen. Teknologisissa mahdollisuuksissa on sektorikohtaisia eroja, jotka heijastuvat innovaatiotoiminnan luonteeseen - erityisesti innovaatioiden kompleksisuuteen. Sektorin suotuisa taloudellinen kehitys puolestaan näyttäisi edesauttavan monimutkaisten innovaatioiden kehittämistä ja tarjoavan laajemman tuotedifferentiaation kautta tilaa inkrementaalisille innovaatioille

Empirical Analysis of Processes underlying Various Technological Innovations

Only abstract. Paper copies of master’s theses are listed in the Helka database (http://www.helsinki.fi/helka). Electronic copies of master’s theses are either available as open access or only on thesis terminals in the Helsinki University Library.Vain tiivistelmä. Sidottujen gradujen saatavuuden voit tarkistaa Helka-tietokannasta (http://www.helsinki.fi/helka). Digitaaliset gradut voivat olla luettavissa avoimesti verkossa tai rajoitetusti kirjaston opinnäytekioskeilla.Endast sammandrag. Inbundna avhandlingar kan sökas i Helka-databasen (http://www.helsinki.fi/helka). Elektroniska kopior av avhandlingar finns antingen öppet på nätet eller endast tillgängliga i bibliotekets avhandlingsterminaler.The aim of this study was to analyse systematic differences in the processes underlying different types of innovations. Innovations were differentiated according to their technological nature, which was measured by the radicalness and the complexity of the innovations. The innovations studied were divided into radical and incremental and into complex and simple innovations. Probit models were used to analyse how the development processes underlying radical versus incremental or complex versus simple innovations differ. The theoretical framework of the study was provided by the literature on different innovation theories. The components of the innovation process in focus can be divided into innovation-specific and firm- or sector- specific factors. Innovation-specific factors were related to the origin of the innovation, collaboration during the development work and the role of public subsidies in the innovation process. Firm- and sector-specific factors in turn consisted of the knowledge base of the innovating firm, the size of the firm and the environment in which the innovation was developed. The starting point for the analysis was a unique innovation database collected by the VTT Group for Technology Studies. The database consists of basic information on some 1600 Finnish innovations commercialised in Finland mainly during the 1980s and 1990s and more detailed survey data on some 800 innovations. The analysis was based on a subgroup of this survey data, consisting of 768 innovations. Patent data and firm-level information were linked to the survey data. The results indicate the importance of scientific and technological knowledge in developing radical or complex innovations. The importance of scientific breakthroughs and new technologies as well as collaboration with universities and research centres was pronounced in the case of radical or complex innovations. On the other hand, innovations originating mainly from competitive pressure were more likely to be incremental. The role of public subsidies in research and development work was highlighted in the development of radical or complex innovations. The results also suggest that the environment in which innovations are developed has an effect on the type of innovative activity. Technological opportunities differ among sectors, which is reflected especially in the complexity of innovation. Favourable demand conditions in turn enhance the development of complex innovations, while at the same time allowing room for incremental innovations through more extensive product differentiation

Selection or self-rejection? : applications into a voluntary treatment program : the case of R&D subsidies

To study how an R&D subsidy program works, we build and estimate a structural model of application and selection into a treatment program. The treatment outcome depends on the investments of both the participant and the public agency running the program. Testing the model with project level data we find that larger firms have higher marginal profitability of R&D and that rates of return on R&D are high and skewly distributed. Firms submit subsidy applications for R&D projects whose median expected discounted profit without subsidies is 500 000 euros, which is increased by 12 000 by expected subsidies. If a firm is classified as an SME, it receives higher subsidies, but conditioning on SME status, subsidies are increasing in the size of the firm. Subsidies are also increasing in technical challenge of the project, and they increase the public agency’s utility not appropriated by the applicant by 16 000 in the median. Non-applicants have lower expected subsidies and higher application costs. Application costs are inversely related to the number of previous applications and directly related to profitability shocks. Consequently, ignoring application costs severely biases the estimated rates of return upwards

Allocation and effects of R&D subsidies : selection, screening and strategic behavior

Allocation and effects of R&D subsidies: selection, screening, and strategic behavior Tanja Tanayama Helsinki School of Economics Abstract This dissertation consists of four essays on the functioning of public research and development (R&D) subsidy programs. The topic of the first three essays is the selection process, also referred to as the participation process. The participation process consists of two decision problems: firms have to decide on whether to apply for a subsidy or not and the government agency allocating subsides has to decide on the subsidy. In the first essay we develop a fully structural model describing the two decision problems in the context of firms that engage in R&D to maximize profits and a public agency that decides on R&D subsidies to maximize its benefits. In the second and the third essay I examine more in detail the application and the allocation decisions respectively. In the fourth essay I take a different angle and develop a theoretical model to examine whether R&D subsidies can alleviate financial constraints and through which channels this effect comes from. In the first essay we develop a new structural method to estimate the expected returns to R&D, their distribution, and their determinants, including the effect of possible subsidies. First a model of continuous optimal treatment with outcome heterogeneity is developed, where the treatment outcome depends on the applicant’s investment. The model takes into account application costs, and isolates the effect of the treatment on the public agency running the treatment program. Under the assumption of a welfare-maximizing agency, the model generates expected general equilibrium treatment effects and social returns to R&D. Then the model is taken to project level data from the Finnish Funding Agency for Technology and Innovation (Tekes) granting process of R&D subsidies. The findings indicate that expected returns on R&D are high, their distribution skew, and treatment effect heterogeneity substantial. Agency’s utility not appropriated by the applicant is linear in R&D. The median increase in this expected agency specific utility from subsidies is 44 000 euros. Ignoring application costs severely biases the estimated treatment effects and returns upwards. In the second essay I analyze the application for R&D subsidies. Finnish firmlevel data on applicants and potential applicants is used to characterize the application behavior of firms. In addition to analyzing the characteristics underlying application for R&D subsidies, also the use of count data models in modeling the application for R&D subsidies is examined. The findings suggest that firms that are the most likely to have eligible projects, are also aware of the 1 R&D subsidy program. The results also suggest that the opportunity cost of applying is lower for firms quite at the beginning of their life cycle. In addition the results provide evidence that external knowledge is important in lowering the application cost. Industry level heterogeneity in application behavior seems to be related to the application activity of potential applicants rather than the awareness of the program. The model selection exercise indicates that in using a count data framework to model the application behavior it is important to take into account both unobserved heterogeneity and excess zeros. The third essay examines the allocation rule of the public agency. R&D subsidies to business sector constitute a selective policy tool to encourage private R&D activities. The efficiency and functioning of this tool depends on how the public agency allocates subsidies. The program under scrutiny is that of Tekes. The results indicate that in general Tekes adheres to the stated funding policy and criteria. The technological content of a project proposal and risks related to the implementation of the project are important in determining both whether an application is accepted and the subsidy-level. In addition being a small and medium size company increases the acceptance probability. Also the extent of collaboration matters. All these findings are in line with the stated funding policy and criteria. However, Tekes seems to be averse to risks related to the commercial potential of the project proposal. It can be questioned whether this observation is in line with the stated objectives. The fourth essay analyzes the role of R&D subsidies in reducing possible adverse selection based financing constraints related to innovation financing. Asymmetric information about the quality of an innovation project between the entrepreneur and the financier leads to a higher cost of external than internal capital, creating a funding gap. This funding gap may prevent especially small and new technology-based firms from undertaking economically viable innovation projects. Results indicate that under certain conditions, public R&D subsidies can reduce these financing constraints. Two different channels generate this effect. First, the subsidy itself reduces the capital costs related to the innovation projects by reducing the amount of external capital required. Second and more important, the observation that an entrepreneur has received a subsidy for an innovation project provides an informative signal to the market-based financier