SOFT BUDGET CONSTRAINT AND THE OPTIMAL CHOICES OF RESEARCH-AND-DEVELOPMENT PROJECTS FINANCING

Through analyzing the softness and hardness of budgeting constraints i n research and development (R&D) investment under different institutio ns, we develop a theory of optimal R&D financing. Our theory not only provides a clear comparison of investment efficiency between centraliz ed economies and market economies but also extends the analysis of sof t budget constraint to firms in market economy. Based on this theory, we characterize optimal choices of R&D project financing in centralize d and decentralized economies. Our results explain why some projects a re financed internally by a large firm but others are cofinanced exter nally by several firms. We also explain what makes a centralized econo my inefficient in R&D. (C) 1998 Academic Press.