We present a theoretical framework which allows for the comparison of the effectiveness of tax measures, loans and funding, in supporting industry-oriented research. We estimate for each of the instruments the exact contribution required by a firm to decide on investing in R&D, given the costs and probability of success of the project, and the foreseen change in profit following successful implementation of the research results. We apply Prospect Theory to analyse the risk attitude of the firm. By comparing the contribution required, we identify the instrument which is most effective, and therefore preferred by a government. Our analysis indicates that there exists a critical value for the probability of success of the project for which the modality of the most effective instruments changes. For a probability of success smaller than the critical value, a tax measures offering support only in case of successful completion of the project is preferred. For a probability higher than the critical value, a loan is most effective. The value of the critical probability depends on the perception of risk and loss aversion of the firm involved in the research.

R&D, firms, innovation, public policy
Criteria for Decision-Making under Risk and Uncertainty (jel D81), Government Policy (jel O38)
Tinbergen Institute
hdl.handle.net/1765/22550
Tinbergen Institute Discussion Paper Series
Discussion paper / Tinbergen Institute
Tinbergen Institute

de Heide, M.J.L, & Kothiyal, A.V. (2011). How to select Instruments supporting R&D and Innovation by Industry (No. TI 2011-021/4). Discussion paper / Tinbergen Institute. Tinbergen Institute. Retrieved from http://hdl.handle.net/1765/22550