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Optimal Design of Research Contests

  • Yeon-Koo Che

    (University of Wisconsin - Madison)

  • Ian Gale

    (Georgetown University)

Many new products (e.g., weapons systems) require substantial innovative effort by suppliers. Procurement of effort through bilateral contracting is often problematic, however, because the effort may be unverifiable and cooperative. That is, a third party cannot verify the level of effort, and the procurer receives a substantial fraction of the value created by the effort. In addition, bankruptcy concerns and legal restrictions limit the ability of the procurer to charge entry fees (we refer to this as limited liability). Procurers often rely on contests in such an environment. For example, the U.S. Federal Communications Commission sponsored a competition to develop the technology for high-definition television. This paper finds the optimal procurement mechanism when unverifiability, cooperativeness and limited liability are present. We accomplish this through the use of a novel duality argument. (The standard mechanism design methodology cannot be used because two mechanisms that are ex post efficient may induce different investment decisions, hence different distributions of types.) Holding an auction with two firms and no reserve price is optimal for the procurer, when the firms have the same technology. When the firms have different technologies, an auction involving the two most efficient firms is optimal, with the more efficient firm being handicapped. This paper contributes to mechanism design theory by incorporating ex ante investment incentives into the mechanism design problem. That is, it finds the optimal mechanism with endogenous types. Recent work on research contests and entry into auctions has incorporated an ex ante dimension, but that work takes the form of contest (auction or tournament) as given.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 1784.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:1784
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  1. Leonardo Felli & Kevin Roberts, . "Does Competition Solve the Hold-up Problem?," CARESS Working Papres 00-04, University of Pennsylvania Center for Analytic Research and Economics in the Social Sciences.
  2. Dirk Bergemann & Juuso Vaimaki, 2000. "Information Acquisition and Efficient Mechanism Design," Cowles Foundation Discussion Papers 1248, Cowles Foundation for Research in Economics, Yale University.
  3. Aghion, Philippe & Tirole, Jean, 1994. "Formal and Real Authority in Organizations," IDEI Working Papers 37, Institut d'Économie Industrielle (IDEI), Toulouse.
  4. Harold L. Cole & George J. Mailath & Andrew Postlewaite, 1998. "Efficient non-contractible investments," Staff Report 253, Federal Reserve Bank of Minneapolis.
  5. Donald B. Hausch & Yeon-Koo Che, 1999. "Cooperative Investments and the Value of Contracting," American Economic Review, American Economic Association, vol. 89(1), pages 125-147, March.
  6. French, Kenneth R & McCormick, Robert E, 1984. "Sealed Bids, Sunk Costs, and the Process of Competition," The Journal of Business, University of Chicago Press, vol. 57(4), pages 417-41, October.
  7. Baye, Michael R & Kovenock, Dan & de Vries, Casper G, 1993. "Rigging the Lobbying Process: An Application of the All-Pay Auction," American Economic Review, American Economic Association, vol. 83(1), pages 289-94, March.
  8. Yeon-Koo Che & Ian Gale, 2000. "Optimal Design of Research Contests," Econometric Society World Congress 2000 Contributed Papers 1784, Econometric Society.
  9. Yeon-Koo Che, 1993. "Design Competition through Multidimensional Auctions," RAND Journal of Economics, The RAND Corporation, vol. 24(4), pages 668-680, Winter.
  10. Aghion, Philippe & Bolton, Patrick, 1992. "An Incomplete Contracts Approach to Financial Contracting," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 473-94, July.
  11. Bag, Parimal Kanti, 1997. "Optimal auction design and R&D," European Economic Review, Elsevier, vol. 41(9), pages 1655-1674, December.
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