Publication Type

Journal Article

Version

acceptedVersion

Publication Date

5-2015

Abstract

We analyze optimal contractual arrangements in a bilateral research and development (R&D) partnership between a risk-averse provider that conducts early-stage research followed by a regulatory verification stage and a risk-neutral client that performs late-stage development activities, including production, distribution, and marketing. The problem is formulated as a sequential investment game with the client as the principal, where the investments are observable but not verifiable. The model captures the inherent incentive alignment problems of double-sided moral hazard, risk aversion, and holdup. We compare the efficacy of milestone-based options contracts and buyout options contracts from the client's perspective and identify conditions under which they attain the first-best outcome for the client. We find that milestone-based options contracts always attain the first-best outcome for the client when the provider has some bargaining power in renegotiation and identify their applicability to different R&D partnerships.

Keywords

R&D partnerships, options contracts, double-sided moral hazard, holdup, risk preference

Discipline

Contracts | Operations and Supply Chain Management

Research Areas

Operations Management

Publication

Management Science

Volume

61

Issue

5

First Page

963

Last Page

978

ISSN

0025-1909

Identifier

10.1287/mnsc.2013.1874

Publisher

INFORMS

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.1287/mnsc.2013.1874

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