The Economics of State Subsidies in Early Stage Financing

Abstract

We analyze the effect of state subsidies on early stage investments. In a two‐period investment model with incomplete stage financing contracts, we describe optimal and second‐best investment levels. Optimality depends on external effects: given that private early stage financing generates positive external effects, the subsidies might be designed to use scarce state money most efficiently to mobilize private investment capital. However, a subsidy might also contribute to greater efficiency of the contractual relationship itself without regard to external effects. Refinancing subsidies can be optimal under both perspectives and are always optimal under last of the two approaches. The comparison of the main types of subsidies, i.e. refinancing subsidies, guarantees and direct investments, speaks against the use of guarantees. Finally, we show that our results do also hold if some investors (e.g. venture capitalists) have a superior screening capability.Early Stage Financing, State Subsidies, Investment Decision, Venture Capital, G24, G32, H23,

Venture capital and government involvement from a qualitative systematic literature review perspective

“…We also found two outliers. Bauer -Burghof (2007) investigated the government measures from a theoretical point of view. A merely theoretical basis forms the motivation for the article of Herrera-Echeverri et al (2014) as well, since they want to uncover whether the neoclassical or Keynesian theories on governmental intervention are beneficial for the emerging markets when it comes to the health of the VC industry.…”

“…Based on a theoretical analysis, Bauer -Burghof (2007) proved that the state intervention is most effective using scarce state money meanwhile mobilizing private capital, its role is essentially to promote getting PVC investment. Wonglimpiyarat (2016) also found that the GVC investments in Israel did not crowd out, but crowd in private investments.…”

“…Using an emerging markets database, Herrera-Echeverri et al (2014) found that government spendingincluding GVChas a negative effect on PVC activity, and the best way for the government to support the VC sector is to improve institutional quality and reduce spending. Bauer -Burghof (2007) built a theoretical model which indicated that large amounts of state intervention can crowed out private money.…”

“…This suggestion appeared geographically in the UK (Gill 2015) and Thailand (Wonglimpiyarat 2011). Bauer -Burghof (2007) added that the state should only interfere in the case of an apparent market failure. Some industries depend more on state support such as private biotechnology incubators (Frenkel et al 2008).…”

The Study on Stage Financing Model of IT Project Investment

“…Cornelli and Yosha (1998), Gompers (1995), Sahlman (1990) pointed out the rights that investors could give up the investment liquidate at any stage are not only the pressures on the management of risk enterprises but also the incentives on the management. Therefore, stage financing is a kind of incentive method to risk enterprises [ 5 , 18 – 25 ].…”