DP11904 Prizes versus Contracts as Incentives for Innovation

Author(s): Yeon-Koo Che, Elisabetta Iossa, Patrick Rey
Publication Date: March 2017
Keyword(s): Contract rights, Inducement Prizes, innovation, Procurement and R&D.
JEL(s): D44, D82, H57, O31, O38, O39
Programme Areas: Public Economics, Industrial Organization
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=11904

Procuring an innovation involves motivating a research effort to generate a new idea and then implementing that idea effciently. If research efforts are unverifiable and implementation costs are private information, a trade-ooff arises between the two objectives. The optimal mechanism resolves the tradeoff via two instruments: a monetary prize and a contract to implement the project. The optimal mechanism favors the innovator in contract allocation when the value of innovation is above a certain threshold, and handicaps the innovator in contract allocation when the value of innovation is below that threshold. A monetary prize is employed as an additional incentive but only when the value of innovation is suffciently high.