140 The Impact of the Act for the Development of Biotech and New Pharmaceuticals Industry on Firm Innovation in Taiwan different. David et al. (2000) find that the recipients of tax credits tend to use additional funds from tax credits to preferentially invest in projects with the highest private return because tax credits reduce the marginal cost of R&D. Based on this concept, David et al. (2000) suggest that the stimulating effect of tax incentives is strong in the short-run because the recipients of tax credits tend to concentrate in the projects with short-term prospects. By contrast, firms or projects granted subsidies by government are selected because they can benefit the general social welfare but the firms themselves may not receive benefits. In theory, projects with high expected social benefits but with insufficient private expected returns usually have long-term nature. Therefore, the stimulus effect of tax credits on innovation is generally faster than that of direct subsidies. 2.5 The Effect of the Taiwan Biopharmaceutical Act on R&D In Taiwan, the Biopharmaceutical Act is established to promote R&D investment of biopharmaceutical industry. The Biopharmaceutical Act adopts two main policy tools to stimulate R&D: tax credits and non-tax credits. First, Biopharmaceutical Act provides tax credits on profits if the expenditure of R&D and personnel training of a particular year exceeds the average of the expenditure of the previous two years. This regulation decreases the cost of R&D investment, which is consistent with the theoretical concept of tax credit (David et al., 2000; Czarnitzki et al., 2011). The Act also offers tax credits for holding shares of biopharmaceutical firms and grants tax credits to top executives and technology investors for their new shares in biopharmaceutical firms. Such a regulation can increase equity financing opportunities and is therefore consistent with the argument of previous papers (Brown et al., 2012, 2017; Hsu et al., 2014) that the equity market is more suited to financing R&D investments. Therefore, the decreasing cost of R&D investment and the incentive of equity financing tend to support the financial constraint theory in explaining R&D underinvestment. Based on the comparison of literature between the two policies, if the government wants to more strongly promote R&D, it should adopt tax credits rather than direct subsidies. In fact, the Biopharmaceutical Act primarily uses tax credits. Thus, we infer that the government’s policy is good. In addition, we predict that the effectiveness of Biopharmaceutical Act is stronger in the short run than in the long run because the stimulating effect of tax credits is more rapid than that of direct subsidies (David et al., 2000). Second, the biopharmaceutical industry also provides non-tax credit treatment as
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