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 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. This paper was accepted by Yossi Aviv, operations management.

• 저널Management Science · 61(5) · 963–978
• 토픽Auction Theory and Applications · Management Science and Operations Research
• DOI10.1287/mnsc.2013.1874
• 저자Shantanu Bhattacharya, Vibha Gaba, Sameer Hasija