Prizes versus Contracts as Incentives for Innovation

Abstract

Procuring 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-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 sufficiently high.

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

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