Pooling of Risky Assets and the Intensity of Cooperation in R&D

In the case considered, risk averse firms agree in advance to share R&D results but not R&D costs. Real R&D expenditure is unobservable, which creates a moral hazard problem. The firms contract at the first stage on the intensity of cooperation and at the second stage on the research effort. Moral hazard weakens the firms’ motives to invest in R&D during cooperation. But diversifying the portfolio of R&D projects through cooperation increases firms’ utility. It turns out that in the absence of monitoring, the firms choose either high effort and low intensity of cooperation or, alternatively, low effort and maximal intensity of cooperation. If a firm can monitor a partner’s real R&D effort through a signal, moral hazard can weaken to an extent that risk averse and independent firms choose high effort and maximal intensity of cooperation, even if they were indifferent between high effort and low effort under isolation.