Innovation Contests with Entry Auction

Abstract

We consider innovation contests for the procurement of an innovation under moral hazard and adverse selection. Innovators have private information about their abilities, and choose unobservable effort in order to produce innovations of random quality. Innovation quality is not contractible. We compare two procurement mechanisms -- a fixed prize and a first-price auction. Before the contest, a fixed number of innovators is selected in an entry auction, in order to address the adverse selection problem. We find that -- if effort and ability are perfect substitutes -- both mechanisms implement the same innovations in symmetric pure-strategy equilibrium, regardless of whether the innovators' private information is revealed or not. These equilibria are efficient if the procurer is a welfare-maximizer.

Keywords: Procurement, Contest, Auction, Innovation, Research, Tournament

JEL Classification: D44, D61, D82, H57, O31, O32