Optimal Financing for R&D-Intensive Firms

41 Pages Posted: 11 Sep 2017 Last revised: 20 Aug 2018

See all articles by Richard T. Thakor

Richard T. Thakor

University of Minnesota - Carlson School of Management

Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management; National Bureau of Economic Research (NBER); Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

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Date Written: September 8, 2017

Abstract

We develop a theory of optimal financing for R&D-intensive firms. With only market financing, the firm relies exclusively on equity financing and carries excess cash, but underinvests in R&D. We use mechanism design to examine how intermediated financing can attentuate this underinvestment. The mechanism combines equity with put options such that investors insure firms against R&D failure and firms insure investors against high R&D payoffs not being realized.

Keywords: R&D Investments, Innovation, Capital Structure, Cash Holdings, Mechanism Design

JEL Classification: D82, D83, G31, G32, G34, O31, O32

Suggested Citation

Thakor, Richard T. and Lo, Andrew W., Optimal Financing for R&D-Intensive Firms (September 8, 2017). MIT Sloan Research Paper No. 5240-17. Available at SSRN: https://ssrn.com/abstract=3034428 or http://dx.doi.org/10.2139/ssrn.3034428

Richard T. Thakor (Contact Author)

University of Minnesota - Carlson School of Management ( email )

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Andrew W. Lo

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

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National Bureau of Economic Research (NBER) ( email )

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Massachusetts Institute of Technology (MIT) - Computer Science and Artificial Intelligence Laboratory (CSAIL)

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