Prizes and Lemons: Procurement of Innovation Under Imperfect Commitment

Abstract

The literature on R&D contests implicitly assumes that contestants submit their innovation regardless of its value. This ignores a potential adverse selection problem. The present article analyzes the procurement of innovations when the procurer cannot commit himself to never bargain with innovators who bypass the contest. We compare fixed-prize tournaments with and without entry fees, and optimal scoring auctions with and without minimum score requirement. Our main result is that preventing bypass is more costly in the optimal auction, and the optimal fixed-prize tournament is more profitable than the optimal auction.

Keywords: innovation, contests, tournaments, auctions, bargaining, adverse selection

JEL Classification: C70, D44, D89, L12, O32