Subsidy Entrepreneurs: an Inquiry into Firms Seeking Public Grants

Abstract

This paper studies the incentives and characteristics of firms that apply for, and eventually receive, one or multiple governmental grants intended to stimulate innovation and growth. The analysis departs from a contest model in which entrepreneurs are free to allocate their effort between production and seeking grants. The results suggest that highly productive entrepreneurs abstain from seeking grants, moderately productive firms allocate a share of their effort to grant seeking, and low-productivity firms allocate most resources to seeking grants. Due to their efforts in seeking grants, these low-productive subsidy entrepreneurs also have a relatively high probability of receiving the grants. Using comprehensive data over grants from the three largest grant-distributing agencies in Sweden, we find concordant evidence of a negative relation between the probability of receiving a grant and firm productivity. As we go from single-to multiple-grant-supported firms, this negative relation becomes more pronounced.

Do policy makers take grants for granted? The efficacy of public sponsorship for innovative entrepreneurship

“…To illustrate, firms gain considerable insight into the grant application process with each proposal they submit (Lerner & Kegler, 2000). To the extent that there is a learning process involved in applying for grants, low productive firms will allocate more resources to seeking grants (Gustafsson et al, 2020). When a grant is awarded, firms benefit through interorganizational endorsement (Stuart, Hoang, & Hybels, 1999), which could further strengthen their ability to acquire additional grants (Lerner & Kegler, 2000).…”

“…Public sponsorship not only provides new organizations with the resources necessary to develop and grow, but can also encourage private investment. New organizations lack sufficient cash flow and collateral to pledge for credit and suffer from information asymmetry problems, which in turn makes it difficult to acquire capital from traditional financiers (Gustafsson, Tingvall, & Halvarsson, 2020; Hall & Lerner, 2010). As a consequence, the private sector provides insufficient capital to new firms, resulting in market failure (Lerner, 2000; Lerner & Kegler, 2000).…”

“…As a consequence, the private sector provides insufficient capital to new firms, resulting in market failure (Lerner, 2000; Lerner & Kegler, 2000). Public entities may be able to correct this market failure and stimulate private investment with appropriately targeted subsidies and interventions to high potential firms (Gustafsson et al, 2018). Conventional wisdom is that public funding sends a signal to the market that a venture has legitimacy and political support, is innovative and resourceful, and has strong earning potential (Holmes et al, 2016).…”

“…On the other hand, governments are notoriously inept at “picking winners,” resulting in an inefficient use of public resources (Jacob & Lefgren, 2011) and the crowding out of viable alternatives (David, Hall, & Toole, 2000). Moreover, there is risk that public funding can incentivize unintended behavior such as rent seeking, whereby firms become skilled in securing grants as opposed to creating real market value (Gustafsson, Tingvall, & Halvarsson, 2020).…”

Bureaucrats or Markets in Innovation Policy? – a critique of the entrepreneurial state

“…Firms that are good at securing public grants may in theory be drawn from any tail in the productivity distribution but in practice authorities seek to foster 'highpotential firms' where they seem potential for growth and productivity improvement, meaning that below-average productive firms may easily be lured into a habit of applying for grants and public support rather than seeking to improve their productivity and gain market shares. Such firms in a sense becoming "subsidy entrepreneurs" with lingering low long-term productivity but still being able to hire skilled workers and pay them well, at least for the intermediate time horizon (Gustafsson et al 2019). If grants designed to stimulate innovation instead led to some firms simply specializing in getting grants this may in time create an increasing market for unproductive or even destructive entrepreneurship that compete unfairly with non-subsidies firms (Baumol 1990).…”