Question

External finance for R&D might be more expensive than internal finance. Please choose only one of...

External finance for R&D might be more expensive than internal finance. Please choose only one of the following reasons to explain this argument. • information asymmetries • moral hazard • tax considerations Can you answer this question for me please ? thank you

Homework Answers

Answer #1

Discussion of asymmetric information problem - External finance for R&D might be more expensive than internal finance.

It shall be noted that in the R & D set up, asymmetric information issue refers to the fact that the inventor has better information about the likelihood of success and the nature of the contemplated innovation project than potential investors. Thus, the following pointers discuss the asymmetric information between inventors and investors that results in external finance for R&D being more expensive than internal finance.

It shall be noted that the market place for financing the development of innovative ideas looks like a "lemons" market.

The lemons premium for R & D would be higher than that for the ordinary investment because the investors have more difficulty distinguishing the good projects from the bad ones especially when the project is long-term R & D investment than short-term.

When the level of R & D expenditure is a highly observable signal, the lemons problem is considered mitigated.

On one extreme, the market for R & D would get disappeared if the asymmetrical information issue is too large.

It shall be noted that Firms are reluctant to reveal their innovative ideas to the market place. Given the possibility of existence of substantial cost involved with the revelation of the innovative ideas to competitors, the quality of the signal about the potential project is reduced.

Thus, the implication of asymmetric information along with the costliness of mitigating the problem is that firm and inventors would face a higher cost of external than internal capital for R & D due to lemons premium.

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