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 unveriable and implementation costs are private information, a trade-off arises between the two objectives. The optimal mechanism resolves the trade-off via two instruments: a cash prize and a follow-on contract. It primarily uses the latter, by favoring the innovator at the implementation stage when the value of the innovation is above a certain threshold and handicapping the innovator when the value of the innovation is below that threshold. A cash prize is employed as a supplementary incentive only when the value of innovation is sufficiently high. These features are consistent with current practices in the procurement of innovation and the management of unsolicited proposals.

Keywords

Reference

Yeon-Koo Che, Elisabetta Iossa, and Patrick Rey, “Prizes versus Contracts as Incentives for Innovation”, The Review of Economic Studies, vol. 88, n. 5, October 2021, p. 2149–2178.