DP11904 Prizes versus Contracts as Incentives for Innovation
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.