Prizes Versus Contracts as Incentives for Innovation

Abstract

The procurement of an innovation involves motivating a research effort to generate a new idea and then implementing that idea efficiently. If research efforts are unverifiable and implementation costs are private information, a trade-off 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 sufficiently high.

Keywords: Contract rights, Inducement Prizes, Innovation, Procurement and R&D

JEL Classification: D44, H57, D82, O31, O38, O39