No abstract

Adverse selection, Innovation finance, Financial constraints, R&D subsidies, Certification, D82, G28, H20, O30, O38,

for discussions. We also wish to thank the EU Seventh Framework Programme funding for SIMPATIC and Tekes for financial support. The usual disclaimer applies.

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.