Business Taxation and Venture-Capital-Financed Innovation - 10.1628/001522109X466545 - Mohr Siebeck

Jean-François Tremblay

Business Taxation and Venture-Capital-Financed Innovation

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Jahrgang 65 () / Heft 2, S. 141-161 (21)

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This paper examines a model of sequential cost-saving innovations financed by venture capital. Successful firms in research can enter the market with a cost advantage over older firms and acquire market power. Innovators have the technical knowledge to conduct R&D but lack the necessary financial resources. Their projects are financed by venture capitalists in exchange for a share of future profits. Venture capitalists can also provide advice and support to innovators, which increases the likelihood of success. Moral hazard between innovators and venture capitalists and rent-seeking behavior introduce various distortions in the level of effort provided by venture capitalists, the size of innovations, and the timing of R&D activities. The system of taxes and subsidies on R&D expenditures, capital gains, and capital investment required to induce the social optimum is characterized. Surprisingly, such a tax system must increase the cost of R&D and lower the return to capital.

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