Financing Mechanisms and R&D Investment

Abstract

This paper analyzes how financial institutions affect efficiency in R&D investments by providing a new contractual foundation for soft budget constraints. We show those inefficient elements (informational asymmetries and conflicts of interest among co-investors) in multi-investor financing can be used as, a commitment device to stop bad projects which are discovered ex post. In the case of single investors financing (such as internal financing). However, the commitment device does not exist. Our theory predicts that optimally many investors should finance an R&D project if there are high uncertainties. Otherwise, internal financial preferable. In addition, an institutional cost affects firm decisions and efficiency in R&D investments.