Government Financing of R&D: A Mechanism Design Approach†

Saul Lach*, Zvika Neeman, Mark Schankerman

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

4 Scopus citations


We study how to design an optimal government loan program for risky R&D projects with positive externalities. With adverse selection, the optimal government contract involves a high interest rate but nearly zero cofinancing by the entrepreneur. This contrasts sharply with observed loan schemes. With adverse selection and moral hazard, allowing for two levels of effort by the entrepreneur, the optimal policy consists of a menu of at most two contracts, one with high interest and zero self-financing and a second with a lower interest plus cofinancing. Calibrated simulations assess welfare gains from the optimal policy, observed loan programs, and a direct subsidy to private venture capital firms. The gains vary with the size of the externalities, the cost of public funds, and the effectiveness of the private venture capital industry.

Original languageEnglish
Pages (from-to)238-272
Number of pages35
JournalAmerican Economic Journal: Microeconomics
Issue number3
StatePublished - 2021


FundersFunder number
Maurice Falk Institute for Economic Research in Israel
Israel Science Foundation1508/15
Tel Aviv University


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