Government subsidies for R&D are intended to promote projects with high returns to society but too little private returns to be beneficial for private investors. This may be caused by spillovers or a low appropriability rate. Apart from the direct funding of these projects, government grants may serve as a signal for good investments for private investors. We use a simple signaling model with different types of R&D projects to capture this phenomenon. In a setup where the subsidy can only be used to distinguish between high and low risk projects, government agencys signal is not very helpful for banks. However, if the subsidy is accompanied by a quality signal, it can lead to increased or better selected private investments.
Subsidies Innovation Asymmetric Information Signaling