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Contracting for an Innovation under Bilateral Asymmetric Information

  • Martimort, D.
  • Poudou, J.-C.
  • Sand-Zantman, W.

This article analyzes the optimal contract design between an inventor and a developer. The inventor is privately informed on the value of his idea. The developer must exert some non-verifiable effort to improve the probability of success of this innovation but may also choose to opt out of the relationship upon learning the quality of the idea. While first-best efficiency requires that all marginal returns on innovation be left to the developer, second-best efficiency taking into account this bilateral asymmetric information leads to distort downwards the developer’s incentives to prevent innovators from overstating the value of their ideas. There exists a trade-off between inviting inventor to reveal their ideas and inducing both effort and participation from the developer. The extent of this trade-off depends on the regime of property rights on ideas, i.e., on how easy to steal ideas. Since decreasing the marginal share of developers makes it more difficult to have them participating to the contract, countervailing incentives might sometimes appear. Taking into account those various effects leads to reduce the responsiveness of the contract to the exact value of the idea and might force to give up additional rents to the developer. Some extensions of our framework, including the cases of limited commitment, partial disclosure and double moral hazard, are studied to show the robustness and limits of our previous findings.

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Paper provided by LASER (Laboratoire de Science Economique de Richter), Faculty of Economics, University of Montpellier 1 in its series Cahiers du LASER (LASER Working Papers) with number 2006.19.

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Length: 40 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:mop:lasrwp:2006.19
Contact details of provider: Postal: LASER, Faculté d'Economie, Avenue Raymond Dugrand, CS 79606, 34960 MONTPELLIER Cedex 2, France
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  1. Choi, Jay Pil, 2001. "Technology transfer with moral hazard," International Journal of Industrial Organization, Elsevier, vol. 19(1-2), pages 249-266, January.
  2. Beggs, A. W., 1992. "The licensing of patents under asymmetric information," International Journal of Industrial Organization, Elsevier, vol. 10(2), pages 171-191, June.
  3. Anton, James J & Yao, Dennis A, 1994. "Expropriation and Inventions: Appropriable Rents in the Absence of Property Rights," American Economic Review, American Economic Association, vol. 84(1), pages 190-209, March.
  4. Mailath, George J, 1987. "Incentive Compatibility in Signaling Games with a Continuum of Types," Econometrica, Econometric Society, vol. 55(6), pages 1349-65, November.
  5. Lacker, J.M., 1989. "Optimal Contracts Under Costly State Falsification," Purdue University Economics Working Papers 956, Purdue University, Department of Economics.
  6. Sudipto Bhattacharya & Jay R. Ritter, 1983. "Innovation and Communication: Signalling with Partial Disclosure," Review of Economic Studies, Oxford University Press, vol. 50(2), pages 331-346.
  7. repec:adr:anecst:y:1991:i:24:p:08 is not listed on IDEAS
  8. David Martimort & Wilfried Sand‐Zantman, 2006. "Signalling and the design of delegated management contracts for public utilities," RAND Journal of Economics, RAND Corporation, vol. 37(4), pages 763-782, December.
  9. Inderst, Roman, 1998. "Incentives Schemes as a Signaling Device," Sonderforschungsbereich 504 Publications 98-36, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
  10. Maskin, Eric & Tirole, Jean, 1992. "The Principal-Agent Relationship with an Informed Principal, II: Common Values," Econometrica, Econometric Society, vol. 60(1), pages 1-42, January.
  11. Bhattacharya, S. & Glazer, J. & Sappington, D., 1991. "Licensing and the Sharing of Knowledge in Research Joint Ventures," Discussion Paper 1991-20, Tilburg University, Center for Economic Research.
  12. Beaudry, Paul, 1994. "Why an Informed Principal May Leave Rents to an Agent," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 35(4), pages 821-32, November.
  13. Nancy T. Gallini, 1992. "Patent Policy and Costly Imitation," RAND Journal of Economics, The RAND Corporation, vol. 23(1), pages 52-63, Spring.
  14. Nancy T. Gallini & Brian D. Wright, 1990. "Technology Transfer under Asymmetric Information," RAND Journal of Economics, The RAND Corporation, vol. 21(1), pages 147-160, Spring.
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