Outsourcing of Innovation

This paper looks at the outsourcing of research and development (R&D) activities. We consider cost reducing R&D and allow manufacturing firms to decide whether to outsource the project to research subcontractors or carry out the research in-house. We use a principal- agent framework and cons...

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Bibliographic Details
Published in:Economic theory 2009-03, Vol.38 (3), p.485-515
Main Authors: Lai, Edwin L.-C., Riezman, Raymond, Wang, Ping
Format: Article
Language:English
Subjects:
Bargaining power
Contracts
Economic efficiency
Economic theory
Economic Theory/Quantitative Economics/Mathematical Methods
Economics
Economics and Finance
Elasticity of demand
Equilibrium
Game Theory
Income
Indifference curves
Innovation
Microeconomics
Monopolistic competition
Outsourcing
Principal-agent theory
Product cycles
Product innovation
Public Finance
R&D
Research & development
Research and development
Revenue sharing
Social and Behav. Sciences
Studies
Subcontracting
Subcontractors
Symposium
Symposium on Organizations, Incentives, Heterogeneity and Trade
Technological innovation
Wages
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Summary:This paper looks at the outsourcing of research and development (R&D) activities. We consider cost reducing R&D and allow manufacturing firms to decide whether to outsource the project to research subcontractors or carry out the research in-house. We use a principal- agent framework and consider fixed and revenue-sharing contracts. We solve for the optimal contract under these constraints. We find that allowing for revenue-sharing contracts increases the chance of outsourcing and improves economic efficiency. However, the principal may still find it optimal to choose a contract that allows the leakage to occur—a second-best outcome when leakage cannot be monitored or vrified. Stronger protection of trade secrets can induce more R&D outsourcing without inhibiting technology diffusion and increase economic efficiency, as long as it does not significantly lengthen the product cycle.
ISSN:0938-2259
1432-0479
DOI:10.1007/s00199-007-0326-4