Financing Innovation Hall and Lerner

Topics: Finance, Investment, Cash flow Pages: 64 (16071 words) Published: April 13, 2014
NBER WORKING PAPER SERIES

THE FINANCING OF R&D AND INNOVATION
Bronwyn H. Hall
Josh Lerner
Working Paper 15325
http://www.nber.org/papers/w15325

NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
September 2009

Forthcoming 2010 in Hall, B. H. and N. Rosenberg (eds.), Handbook of the Economics of Innovation, Elsevier-North Holland. We are grateful to Bruce Petersen for a careful reading of the manuscript. The second author thanks the Harvard Business School’s Division of Research for financial support. This chapter is based on material in Hall (2002) and Gompers and Lerner (2004). The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

NBER working papers are circulated for discussion and comment purposes. They have not been peerreviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications.

© 2009 by Bronwyn H. Hall and Josh Lerner. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

The Financing of R&D and Innovation
Bronwyn H. Hall and Josh Lerner
NBER Working Paper No. 15325
September 2009
JEL No. G24,G32,O32,O38
ABSTRACT
Evidence on the “funding gap“ for investment innovation is surveyed. The focus is on financial market reasons for underinvestment that exist even when externality-induced underinvestment is absent. We conclude that while small and new innovative firms experience high costs of capital that are only partly mitigated by the presence of venture capital, the evidence for high costs of R&D capital for large firms is mixed. Nevertheless, large established firms do appear to prefer internal funds for financing such investments and they manage their cash flow to ensure this. Evidence shows that there are limits to venture capital as a solution to the funding gap, especially in countries where public equity markets for VC exit are not highly developed. We conclude by suggesting areas for further research.

Bronwyn H. Hall
Dept. of Economics
549 Evans Hall
UC Berkeley
Berkeley, CA 94720-3880
and NBER
bhhall@nber.org
Josh Lerner
Harvard Business School
Rock Center 214
Boston, MA 02163
and NBER
jlerner@hbs.edu

Financing R&D and Innovation

B. H. Hall and J. Lerner – August 2009

1. INTRODUCTION ..................................................................................................................................... 3 2. RESEARCH AND DEVELOPMENT AS INVESTMENT ................................................................... 5 3. THEORETICAL BACKGROUND ......................................................................................................... 8 3.1 ASYMMETRIC INFORMATION PROBLEMS ................................................................................................ 9 3.2 MORAL HAZARD PROBLEMS ................................................................................................................ 10 3.3 CAPITAL STRUCTURE AND R&D .......................................................................................................... 12 3.4 TAXES AND THE SOURCE OF FUNDS ..................................................................................................... 14 4. TESTING FOR FINANCIAL CONSTRAINTS................................................................................... 16 5. SMALL FIRMS, STARTUP FINANCE, AND VENTURE CAPITAL ............................................. 24 5.1 VENTURE INVESTING ........................................................................................................................... 26 5.2 EXITING ............................................................................................................................................... 29 5.3 VENTURE FUND-RAISING...

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