It can be construed as a government venture capital initiative where public financing underwrite the research and development of early-stage technologies and processes (Branscomb & Keller, 1998; Lerner, 1999). As Borrus and Stowsky (1999) put it, technology programs like the SBIR, which stimulate the development of new industrial technologies, could be regarded as bets on the country’s technological future.
The SBIR subsidy helps small firms satisfy the required minimum scale of R&D (e.g. minimum size and competence of the R&D team) necessary to achieve results. It allows, for example, the hiring of university scientists or engineers to spearhead or support its R&D effort. More importantly, the SBIR grant may also enable the recipient small firm to engage in more R&D projects and thus utilize whatever R&D facility and equipment it has set up originally to full capacity. Engaging in more R&D projects while utilizing the same level of resources the firm possessed prior to the SBIR grant decreases the unit cost of innovation to be derived from the new and more intensified R&D effort. The recipient’s innovative effort becomes less costly at a larger scale of R&D, which is exactly the competitive advantage of large firms with large R&D departments over small firms with meager R&D budgets.
Public financing shifts the recipient-firm’s marginal cost to the right (David, Hall & Toole, 2000; Metcalfe, 1995) pushing its innovation effort theoretically up to a level that closes the gap between the private level and the “socially optimal level” of R&D. The economy-wide benefits of more small firms conducting R&D in the high-technology sector as a result of the availability of SBIR grants multiply when the knowledge derived
from publicly co-financed R&D spills over to other users and producers of innovations. Public financing also alleviates the risks and uncertainties of the outcomes of R&D effort. By providing small firms the opportunity to engage in longer-term R&D, SBIR enables recipients to have a better estimate of the reward and risk of developing their intended new products or processes. Using the SBIR research grant, a better evaluation of the probability of technical and market success will encourage the recipient small firm to further develop the technology in the future with or without public financing. The prospect of having federal agencies procure the proposed technology to pursue their agency missions also lowers market uncertainties for some SBIR-financed research projects. The increase in the innovation effort of recipient firms as a result of public financing alleviating the problems of indivisibilities, technology spillovers, and negative risk evaluation is the so-called additionality effect of research, innovation, and
technology policies (Clarysse, Wright, & Mustar, 2009; Georghiou, 2002). The SBIR program offers financing to new innovative small enterprises to develop unproven but promising technologies (Toole & Czarnitzki, 2007). The availability of public financing to small high tech firms at the seed or start-up stage of technology development, a critical stage in which private investors like venture capitalists are still reluctant to participate (Cooper, 2003), encourages small enterprises to pursue technological innovations (Gonzalez, Jaumandreu & Pazo, 2005).
The SBIR grant can also have a halo or certification effect specifically in the application for external capital (Lerner, 1999; Link & Scott, 2010). Recipient small firms can leverage their SBIR awards to signal the “viability of the project and the company” (Siegel, Wessner, Binks, & Lockett, 2003, p. 124). SBIR’s certification effect is similar
to the warranty effect in Akerlof’s (1970) “lemons” market problem14; the SBIR funding certifies that the innovation project is not a “lemon” and thus is worthy of capital infusion or credit extension at a rate lower than what would be possible when the capital providers do not have a hint on the quality of the innovation project. Using a Net Present Value model, Toole and Turvey (2009, p. 45) have shown that when initial public investment (such as that provided by SBIR grants) are used “to support research necessary to reduce technical and market uncertainties,” capital providers will be encouraged to undertake follow-on investment. Thus, SBIR funding helps address the information asymmetry problem by certifying that the proposed new technology is both (a) “scientifically sound” and (b) “commercially promising” (Feldman & Kogler, 2008, p. 442), providing the extra push to financiers to extend additional capital funding. Lerner (1999) showed that small firms that received SBIR grants are three times more likely than non-recipients to attract venture capital, a finding validated by a more recent study by Toole and Turvey (2009) who documented that SBIR Phase I grants have a positive effect on receiving follow-on external private investment.
From an evolutionary economic perspective and national innovation systems approach, which rejects the role of public policy to achieve an “optimal” state of the innovation system, R&D subsidy programs like the SBIR are meant to “influence the nature of the knowledge base of the firm” and to “increase absorptive capacity” (Soete, Verspagen & Weel, 2010, p. 1169). The innovation system fails when producers of innovation, which are generally firms, do not have the capacity to translate or at least
adapt existing innovations and research produced by other firms, universities, and other research institutes to products, processes, marketing strategies, or organizational forms that can increase their own productivity and competitive advantage. The SBIR grant enables small firms to experiment with new processes, technologies, and organizational forms providing a critical opportunity for firms to learn by doing. Not all firm
innovations are derived entirely from R&D; they also originate among others from the production floor, interactions between technical and nontechnical personnel, and
interactions with users and customers. SBIR funding can have long-run learning effects that enhance the efficiency of future R&D programs of the recipient firm (David, Hall & Toole, 2000).
This dissertation focuses on testing the additionality and certification effects of the SBIR program as well as its effects on other metrics of post-entry performance like sales and employment size.
2.2. Related Studies