A comparison of milestone-based and buyout options contracts for coordinating R&D partnerships
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...
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| Main Authors: | , , |
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| Format: | text |
| Language: | English |
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Institutional Knowledge at Singapore Management University
2015
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| Subjects: | |
| Online Access: | https://ink.library.smu.edu.sg/lkcsb_research/5104 https://ink.library.smu.edu.sg/context/lkcsb_research/article/6103/viewcontent/mnsc_2E2013_2E1874__1_.pdf |
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| Institution: | Singapore Management University |
| Language: | English |
| Summary: | 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. |
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