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Abstract

R&D investment differs from general investments due to more and greater uncertainties. Once the R&D technique is selected and the investment turns into sunk cost, a path dependence of the R&D investment will occur that locks in the involved parties in the R&D cooperation relationship and the determined cost path. Due to information asymmetry, whether the executer honestly provides information about the project type will be critical to the profit or loss of the R&D investment. If a high cost type project be confesses, the financier can immediately terminate the project to avoid more losses. On the contrary, if the cost type is concealed, the financier will sink more costs into it. Thus, soft budget constraint should be seriously considered in R&D investments.
First, we capture the intrinsic uncertainty in R&D investment by introducing both cost and outcome uncertainties of R&D investment. Furthermore, we introduce the financier type and the executor’s expectation of the probability that a high cost project would be refinanced ex post to establish a dynamic game of incomplete information. With this setup, we develop reputation effects from repeated R&D games. The incentive for the financier to avoid executor’s opportunism by establishing reputation makes the commitment to hard budget constraint credible.
Second, we attempt to develop a foundation for the concept of the SBC and to extend the analysis of SBCs to the contractual relationship of R&D investment. Information asymmetry is one important cause for contractual incompleteness, and the only one cause makes two legal contract theories unhelpful. Instead of relying on court enforcement, it is possible for the financier to leave contract terms unspecified and rely on a private self-enforcement mechanism. Writing down explicit contract terms can define the self-enforcing range by imposing a private sanction on the executer perceived to be violating the contract understanding. Such a self-enforcing relationship is a useful framework in which to analyze the SBC of R&D investment.
In Chapter 5, we describe industrial R&D activities in China and uses statistics to calculate the softness of budget constraint. The main point of the R&D investment model is that the incentive for the financier to establish reputation increases as the probability of success decreases. With this point of view, given the probability of success for R&D projects in high-tech industries being lower than that in conventional industries, refinancing should be relatively more common in conventional industries than in high-tech industries. Statistics of R&D activities in China confirm the above proposition in that the computer-related industry has the hardest budget constraint compared to other industries within the state-controlled sector.

Contents

Chapter 1 Introduction
1. Research Motivation 1
2. Major Issues 6
3. Research Objectives 7
4. Organization of Chapters 9

Chapter 2 Theory Research and Literature Review
1. The Basic Concept of the Soft Budget Constraint 11
2. Policy Burdens and the Soft Budget Constraint 13
3. Time Inconsistency and the Commitment Problem 15
4. The Soft Budget Constraint and Financial Crisis 17
5. Questions and Discussion 18

Chapter 3 Reputation effects and SBCs of internally financed R&D investments
1. Introduction 22
2. Basic model 26
3. One-round R&D investment game 29
4. Two-round R&D investment game 35
5. Concluding remarks 43

Chapter 4 The SBC and Contractual Relationship in R&D Investment
1. Introduction 45
2. Legal contract theory and contractual relationship of R&D investment 49
3. The private self-enforcement mechanism 54
4. The model 58
5. Transaction cost of self-enforcing arrangement 61
6. Concluding remarks 67

Chapter 5 The SBC and R&D Efficiency
1. Introduction 70
2. R&D and softness of different industries in China 74
3. A theoretical examination of R&D efficiency 82
4. The empirical methodology and results 88
5. Concluding remarks 93

Chapter 6 Conclusions
1. Concluding remarks 95
2. Research Limitation and Directions for Future Studies 99

Reverences 102

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