NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
loading...

Optimal Financing for R&D-Intensive Firms

Richard T. Thakor, Andrew W. Lo

NBER Working Paper No. 23831
Issued in September 2017
NBER Program(s):Corporate Finance, Health Economics, Productivity, Innovation, and Entrepreneurship

We develop a theory of optimal financing for R&D-intensive firms that uses their unique features—large capital outlays, long gestation periods, high upside, and low probabilities of R&D success—that explains three prominent stylized facts about these firms: their relatively low use of debt, large cash balances, and underinvestment in R&D. The model relies on the interaction of the unique features of R&D-intensive firms with three key frictions: adverse selection about R&D viability, asymmetric information about the upside potential of R&D, and moral hazard from risk shifting. We establish the optimal pecking order of securities with direct market financing. Using a tradeoff between tax benefits and the costs of risk shifting for debt, we establish conditions under which the firm uses an all-equity capital structure and firms raise enough financing to carry excess cash. A firm may use a limited amount of debt if it has pledgeable assets in place. However, market financing still leaves potentially valuable R&D investments unfunded. We then use a mechanism design approach to explore the potential of intermediated financing, with a binding precommitment by firm insiders to make costly ex post payouts. A mechanism consisting of put options can be used in combination with equity to eliminate underinvestment in R&D relative to the direct market financing outcome. This optimal intermediary-assisted mechanism consists of bilateral “insurance” contracts, with investors offering firms insurance against R&D failure and firms offering investors insurance against very high R&D payoffs not being realized.

download in pdf format
   (456 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w23831

Users who downloaded this paper also downloaded* these:
Bloom, Jones, Van Reenen, and Webb w23782 Are Ideas Getting Harder to Find?
Edmans, Gabaix, and Jenter w23596 Executive Compensation: A Survey of Theory and Evidence
Jørring, Lo, Philipson, Singh, and Thakor w23344 Sharing R&D Risk in Healthcare via FDA Hedges
Dave, Cotet-Grecu, and Saffer w23537 Mandatory Access Prescription Drug Monitoring Programs and Prescription Drug Abuse
Kaplan and Sorensen w23832 Are CEOs Different? Characteristics of Top Managers
 
Publications
Activities
Meetings
NBER Videos
Themes
Data
People
About

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us