Publication Type

Journal Article

Version

Postprint

Publication Date

2-2013

Abstract

We examine how a licensor can optimally design licensing contracts for multi-phase R&D projects when he does not know the licensee’s project valuation, leading to adverse selection, and cannot enforce the licensee’s effort level, resulting in moral hazard. We focus on the effect of the phased nature typical of such projects, and compare single-phase and multi-phase contracts. We determine the optimal values for the upfront payment, milestone payments and royalties, and the optimal timing for outlicensing. Including multiple milestones and accompanying payments can be an effective way of discriminating between licensees holding different valuations, without having to manipulate the royalty rate, which induces licensees to invest less, resulting in lower project values and socially suboptimal solutions. Interestingly, we also find that multiple milestone payments are beneficial even when the licensor is risk-averse, contrary to standard contract theory results, which recommend that only an upfront payment should be used. In terms of licensing timing, we show that the optimal time depends on the licensor’s risk aversion, the characteristics of the licensee and the project value.

Keywords

Research and development, Innovation, Contract design, Asymmetric information, Industries, Pharmaceutical

Discipline

Operations and Supply Chain Management | Technology and Innovation

Research Areas

Operations Management

Publication

European Journal of Operational Research

Volume

224

Issue

3

First Page

572

Last Page

582

ISSN

0377-2217

Identifier

10.1016/j.ejor.2012.09.014

Publisher

Elsevier

Additional URL

http://dx.doi.org/10.1016/j.ejor.2012.09.014

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