Survey_HW_2009

Abstract

We consider the organization of innovative activities between a supplier (firm S) and a manufacturer (firm M). Innovative activities result in new or improved inputs into M’s final product. Thereby, successful innovations increase the value of M’s final product. Firm S is a specialized supplier with an accumulated stock of expertise in the field. The supplier has to incur an investment in order to initiate the R&D process. Since we aim to focus our analysis on the interaction of firms M and S in later stages of the innovation process we choose a fixedinvestment approach for the investment in the research phase. For matters of notational simplicity we normalize these investment costs to zero. Furthermore, without loss of generality we assume a deterministic relationship between R&D input and the value of the R&D outcome. Due to the high degree of uncertainty it is not feasible to write ex-ante a contract which describes the crucial characteristics of the new input in a verifiable manner. This is akin to the notion that there are many potential outcomes and it is prohibitively expensive ex-ante to describe which should be implemented but costless to do so ex-post (given that both firms are active in the R&D process) and the two firms cannot commit not to renegotiate (see Hart and Moore (1999)). Due to contractual incompleteness ownership rights matter. Ownership gives the right to determine on the implementation of the outcome of the research process. We refer to this outcome in the following as patent. In an extension we allow for the renegotiation of this right in later stages.