Evidence on the “funding gap“ for investment innovation is surveyed. The
focus is on financial market reasons for underinvestment that exist even
when externality-induced underinvestment is absent. We conclude that
while small and new innovative firms experience high costs of capital
that are only partly mitigated by the presence of venture capital, the
evidence for high costs of R&D capital for large firms is mixed.
Neverthless, large established firms do appear to prefer internal funds
for financing such investments and they manage their cash flow to ensure
this. Evidence shows that there are limits to venture capital as a
solution to the funding gap, especially in countries where public equity
markets for VC exit are not highly developed. We conclude by suggesting
areas for further research.
Keywords: innovation, R&D, financing, liquidity constraints, venture capital, cash flow
JEL codes: G24, G32, O32, O38
UNU-MERIT Working Papers ISSN 1871-9872