How is Moral Hazard Related to Financing R&D and Innovations?

Abstract

1. Introduction The moral hazard has a potential to arise through the information asymmetry between suppliers of funds to Research and Development (RD Aren at al. 2012). Consequently, these loans have less potential to play an effective role in pre-committing investors to punish the low efforts of firms. To our knowledge, there is no prior study looking at the direct role of moral hazard in financing R&D and innovations. The closest to ours is the study by Svensson (2013) who focuses on the nature of the contract terms as a remedy for the moral hazard arising between owners of the patents and their external financiers. Other studies tackle the moral hazard between entrepreneurs and venture capitalists. Chan et al. (1990) explain the optimal transition of control between entrepreneur and venture capitalist in a model with initial uncertainty about the skill of the entrepreneur. Similarly Bergemann and Hege (1998) states that optimal contract between entrepreneur and venture capitalist should be different from a standard debt contract given that entrepreneur's effort is not verifiable. Our results show that as the size of the loan increases firms are less prone to moral hazard. For family firms, our results support the agency theory. For large shareholders, initially our results are aligned with the agency theory but after controlling for the loan size our results hold for the stewardship theory. Finally we find that as the amount of loan increases relative to the size of a firm, the performance of projects financed by these loans fall and the performance varies across different industries. …