Innovation Performance and Government Financing

External financing is important when inventors and small technology-based firms commercialize their inventions. However, the private information of inventors about the quality of their products causes information asymmetries and moral hazard problems. To help compensate for potentially non-existing capital markets, the Swedish Government has intervened by offering loans with different terms to firms and inventors. This paper analyzes the association between various forms of external financing and performance in profit-terms when patents are commercialized. The empirical work is based on a patent survey sent to Swedish inventors and small firms, where the response rate is 80 %. The estimations show that projects with soft government financing in the R&D-phase have a significantly inferior performance compared to projects without such financing, whereas those receiving government loans on commercial terms perform as the average. Distinguishing between governmental financing alternatives with different terms makes it possible to draw the conclusion that government failure primarily depends on bad financing terms, rather than bad project selection. A policy implication is therefore that public loans should be granted on commercial terms already in the R&D-phase of projects. -------------------------------* Associate Professor; Research interests: entrepreneurship, small business, patents, service sectors. The author would like to thank Erik Mellander, Magnus Henrekson, Tino Sanandaji and the participants at the CBER conference in Copenhagen and the NCSB conference in Stockholm for constructive comments. Jakob Eliasson provided excellent research assistance. Marianne and Marcus Wallenberg’s Foundation and The Bank of Sweden are acknowledged for generous financial support.