Outsourcing of Innovation

41 Pages Posted: 5 Oct 2006

See all articles by Edwin L.-C. Lai

Edwin L.-C. Lai

Hong Kong University of Science & Technology (HKUST) - Department of Economics

Raymond G. Riezman

University of Iowa - Henry B. Tippie College of Business - Department of Economics; Aarhus University - Department of Economics and Business; University of California, Santa Barbara (UCSB) - Department of Economics; GEP; CESifo (Center for Economic Studies and Ifo Institute)

Ping Wang

Washington University in St. Louis - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: September 2005

Abstract

This paper looks at the outsourcing of research and development (R&D) activities. We consider cost reducing R&D and allow manufacturing firms to decide whether to outsource the project to research subcontractors or carry out the research in-house. We use a principal-agent framework and consider fixed and revenue-sharing contracts. We solve for the optimal contract under these constraints. We find that allowing for revenue-sharing contracts increases the chance of outsourcing and improves economic efficiency. However, the principal may still find it optimal to choose a contract that allows the leakage to occur -- a second-best outcome when leakage cannot be monitored or verified. Moreover, stronger protection of intellectual property need not induce more R&D outsourcing nor improve welfare.

Keywords: R&D Outsourcing, Principal-Agent Problem, Fixed versus Revenue-Sharing Contract

JEL Classification: D21, O31, L14

Suggested Citation

Lai, Edwin L.-C. and Riezman, Raymond G. and Wang, Ping, Outsourcing of Innovation (September 2005). Available at SSRN: https://ssrn.com/abstract=935003 or http://dx.doi.org/10.2139/ssrn.935003

Edwin L.-C. Lai (Contact Author)

Hong Kong University of Science & Technology (HKUST) - Department of Economics ( email )

Clear Water Bay
Kowloon, Hong Kong
China

Raymond G. Riezman

University of Iowa - Henry B. Tippie College of Business - Department of Economics ( email )

316 PBB
Iowa City, IA 52242
United States

HOME PAGE: http://www.biz.uiowa.edu/faculty/rriezman/

Aarhus University - Department of Economics and Business ( email )

Fuglesangs Alle 4
Aarus, 8210
Denmark

HOME PAGE: http://www.biz.uiowa.edu/faculty/rriezman/

University of California, Santa Barbara (UCSB) - Department of Economics ( email )

2127 North Hall
Santa Barbara, CA 93106
United States

GEP ( email )

University Park
Nottingham, NG7 2RD
United Kingdom

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.cesifo.de

Ping Wang

Washington University in St. Louis - Department of Economics ( email )

One Brookings Drive
St. Louis, MO 63130
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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