Incentives in a Stage-Gate Process

30 Pages Posted: 12 Jan 2011 Last revised: 10 May 2013

Raul O. Chao

University of Virginia - Darden School of Business

Kenneth C. Lichtendahl Jr.

University of Virginia - Darden School of Business

Yael Grushka-Cockayne

University of Virginia - Darden School of Business

Date Written: June 11, 2012

Abstract

Many large organizations use a stage-gate process to manage new product development projects. In a typical stage-gate process project managers learn about potential ideas from research and exert effort in development while senior executives make intervening go/no-go decisions. This decentralized decision making results in an agency problem because the idea quality in early stages is unknown to the executive and the project manager must exert unobservable development effort in later stages. In light of these challenges, how should the firm structure incentives to ensure that project managers reveal relevant information and invest the appropriate effort to create value? In this paper, we develop a model of adverse selection in research and moral hazard in development with an explicit go/no-go decision at the intervening gate. Our results show that the principal's uncertainty regarding early-stage idea quality --- a term we refer to as idea risk --- alters the effect of late-stage development risk. The presence of idea risk can lead the firm to reject projects that otherwise seem favorable in terms of positive net present value. A simulation of early-stage ideas, found through search on a complex landscape, shows that the firm can mitigate the negative effects of idea risk by encouraging breadth of search and high tolerance for failure.

Keywords: Innovation; New Product Development; Principal-Agent Analysis; Search; Complex Performance Landscapes

JEL Classification: O31, O32, D82, D83, L24

Suggested Citation

Chao, Raul O. and Lichtendahl, Kenneth C. and Grushka-Cockayne, Yael, Incentives in a Stage-Gate Process (June 11, 2012). Darden Business School Working Paper No. 1738531. Available at SSRN: https://ssrn.com/abstract=1738531 or http://dx.doi.org/10.2139/ssrn.1738531

Raul O. Chao (Contact Author)

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-982-2681 (Phone)

Kenneth C. Lichtendahl Jr.

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

Yael Grushka-Cockayne

University of Virginia - Darden School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States

Paper statistics

Downloads
310
Rank
78,289
Abstract Views
1,847