R&D, Risk, and the Role of Targeted Government R&D Programs

This paper clarifies the role of passive incentives and targeted government R&D support programs in R&D policy. Using a principal-agent framework, a theoretical model of firm R&D behavior is developed, and suggests that without targeted R&D support programs many R&D projects with the greatest spillover potential would never be undertaken. Passive incentives encourage the firm to conduct a greater amount of R&D, while targeted support encourages the firm to pursue R&D projects it would not normally undertake. These results are independent of the effect of government R&D dollars on private R&D dollars. We incorporate risk into the model to examine programs where targeted funding is reserved for high risk projects. Our theoretical results support current practice of these programs: high risk, high reward R&D projects that would not normally be undertaken by private firms are supported. However, constraining these programs to focus only on high risk projects may cause low risk projects with greater expected benefits to be ignored