The Handbook of Technology and Innovation Management

15.6. Conclusions

Based on the literature surveyed here, what do we know about the costs of financing innovation investments and the possibility that some kind of market failure exists in this area? Several main points emerge:

• There is fairly clear evidence, based on theory, surveys, and empirical estimation, that small and startup firms in R&D-intensive and high technology industries face a higher cost of capital than their larger competitors and than firms in other industries. In addition to compelling theoretical arguments and empirical evidence, the mere existence of the VC industry and the fact that it is concentrated precisely where these startups are most active suggests that this is so. In spite of considerable entry into the VC industry, returns remain high, which does suggest a high required rate of return in equilibrium.

• The evidence for a financing gap for large and established R&D firms is harder to establish. It is certainly the case that these firms prefer to use internally generated funds for financing investment, but less clear that there is an argument for intervention, beyond the favorable tax treatment that currently exists in many countries.^[]

  ^[] It is important to remind the reader of the premise of this chapter: I am focusing only on the financing gap arguments for favorable treatment of R&D and ignoring (for the present) the arguments based on R&D spillovers and externalities. There is good reason to believe that the latter is a much more important consideration ...