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Step by step. The benefits of stage-based R&D licensing contracts

Crama, P; De Reyck, B; Degraeve, Z; (2013) Step by step. The benefits of stage-based R&D licensing contracts. European Journal of Operational Research , 224 (3) pp. 572-582. 10.1016/j.ejor.2012.09.014. Green open access

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We examine how a licensor can optimally design licensing contracts for multi-phase R&D projects when he does not know the licensee’s project valuation, leading to adverse selection, and cannot enforce the licensee’s effort level, resulting in moral hazard. We focus on the effect of the phased nature typical of such projects, and compare single-phase and multi-phase contracts. We determine the optimal values for the upfront payment, milestone payments and royalties, and the optimal timing for outlicensing. Including multiple milestones and accompanying payments can be an effective way of discriminating between licensees holding different valuations, without having to manipulate the royalty rate, which induces licensees to invest less, resulting in lower project values and socially suboptimal solutions. Interestingly, we also find that multiple milestone payments are beneficial even when the licensor is risk-averse, contrary to standard contract theory results, which recommend that only an upfront payment should be used. In terms of licensing timing, we show that the optimal time depends on the licensor’s risk aversion, the characteristics of the licensee and the project value.

Type: Article
Title: Step by step. The benefits of stage-based R&D licensing contracts
Open access status: An open access version is available from UCL Discovery
DOI: 10.1016/j.ejor.2012.09.014
Publisher version: http://dx.doi.org/10.1016/j.ejor.2012.09.014
Language: English
Additional information: © 2013. This manuscript version is published under a Creative Commons Attribution Non-commercial Non-derivative 4.0 International licence (CC BY-NC-ND 4.0). This licence allows you to share, copy, distribute and transmit the work for personal and non-commercial use providing author and publisher attribution is clearly stated. Further details about CC BY licences are available at http://creativecommons.org/licenses/by/4.0.
Keywords: Research and development, Innovation, Contract design, Asymmetric information, Industries, Pharmaceutical
URI: http://discovery.ucl.ac.uk/id/eprint/1385720
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