TY - JOUR
T1 - Subsidizing research programs with “if” and “when” uncertainty in the face of severe informational constraints
AU - Besanko, David
AU - Tong, Jian
AU - Wu, Jason Jianjun
N1 - Funding Information:
∗Northwestern University; d-besanko@kellogg.northwestern.edu. ∗∗University of Southampton; j.tong@soton.ac.uk. ∗∗∗Compass Lexecon; jwu@compasslexecon.com. The authors would like to thank Alberto Galasso and Nick Klein for their very helpful comments as well as participants at 2009 International Industrial Organization Conference at Boston and 2010 Southwest Economic Theory Conference at Los Angeles. We also thank Mark Armstrong and two anonymous referees for their extremely conscientious reviews and for their valuable suggestions. Besanko gratefully acknowledges the financial support from the National Science Foundation under grant no. 0615615.
Funding Information:
This article is also related to several articles in the broader literature on the financing of innovative activity, in particular, Bergemann and Hege (1998, 2005) and Hörner and Samuelson (2013). These articles, like ours, study R&D projects that are characterized by both “if” and “when” uncertainty. The main focus of these articles is to explore the hidden action (and its induced hidden information) problems in a context of open-ended exclusively external financing. Although it is critical to understand the problem caused by hidden action in R&D experimentation, it is equally important to understand the economics of R&D subsidies in the case of severe information asymmetries. By shifting the emphasis from hidden action to the hidden information problem in the context of a belief-free incomplete information game, this article complements the current literature on funding experimentation by including a number of new important features. First, unlike exclusively external funding, we allow firms to use their own funding to pursue R&D while receiving financial support from the government. Second, we address the appropriability and free-riding problems simultaneously with a funding scheme that includes matching, earmarked, and unrestricted subsidies as special cases, whereas the current literature largely restricts the external financial support to unrestricted funding only. Third, we study the funding policy for multiple firms, whereas the Bergemann and Hege and Hörner and Samuelson articles focus on the one-firm case. Finally, their models assume no friction in external funding, whereas we consider cases with and without frictions in terms of a shadow cost.
PY - 2018/6/1
Y1 - 2018/6/1
N2 - We study subsidy policies for research programs when firms have private information about the likelihood of project viability, but the government cannot form a unique prior about this likelihood. When the shadow cost of public funds is zero, first-best welfare can be attained as a (belief-free) ex post equilibrium under both monopoly and competition, but it cannot be attained when the shadow cost is positive. However, max-min subsidy policies exist under monopoly and competition and consist of pure matching subsidies. Under a Research and Development (R&D) consortium, the highest max-min matching rate is lower than under competition, and R&D investment intensity is higher.
AB - We study subsidy policies for research programs when firms have private information about the likelihood of project viability, but the government cannot form a unique prior about this likelihood. When the shadow cost of public funds is zero, first-best welfare can be attained as a (belief-free) ex post equilibrium under both monopoly and competition, but it cannot be attained when the shadow cost is positive. However, max-min subsidy policies exist under monopoly and competition and consist of pure matching subsidies. Under a Research and Development (R&D) consortium, the highest max-min matching rate is lower than under competition, and R&D investment intensity is higher.
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U2 - 10.1111/1756-2171.12227
DO - 10.1111/1756-2171.12227
M3 - Article
AN - SCOPUS:85046416516
VL - 49
SP - 285
EP - 310
JO - RAND Journal of Economics
JF - RAND Journal of Economics
SN - 0741-6261
IS - 2
ER -