R & D, Innovation, and the Signalling Properties of the firm's Financial Structure

Innovating firms use their finance structure as a signalling device to attract outside investors. This argument is developed in standard static principal-agent models dealing with New Technology Based Firms (NTBFs) and large firms undertaking an aggressive R&D strategy. In the case of NTBFs, the signalling device is implicit in two kinds of optimal financing contracts, which render the sharing rules independent of the agent's action and of both the agent's action and the state of nature (technological regime). Regarding innovating large firms, it is argued that directors use their equity share to signal the firm's expected return stream and value to outside investors.