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

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

Optimal investment under operational flexibility, risk aversion, and uncertainty

Abstract Traditional real options analysis addresses the problem of investment under uncertainty assuming a risk-neutral decision maker and complete markets. In reality, however, decision makers are often risk averse and markets are incomplete. We confirm that risk aversion lowers the probability of investment and demonstrate how this effect can be mitigated by incorporating operational flexibility in the form of embedded suspension and resumption options. Although such options facilitate investment, we find that the likelihood of investing is still lower compared to the risk-neutral case. Risk aversion also increases the likelihood that the project will be abandoned, although this effect is less pronounced. Finally, we illustrate the impact of risk aversion on the optimal suspension and resumption thresholds and the interaction among risk aversion, volatility, and optimal decision thresholds under complete operational flexibility

Licensing Contracts: Control Rights, Options and Timing

Research and development (R&D) collaborations, common in high-tech industries, are challenging to manage because of technical and market risks as well as incentive problems. We investigate how control rights, options, payment terms, and timing allow the innovator to capture maximum value from its R&D collaborations with a marketer. Our study reveals a counterintuitive result; the innovator may, under certain conditions, prefer to grant launch control rights or buyout options to the marketer despite the fact that both terms restrict its downstream actions. We demonstrate that a menu of contracts is not necessary to address the adverse selection problem because the menu can be replicated by a single option contract. We show that timing, through renegotiation or delayed contracting, as well as the careful allocation of control rights and options can have a significant influence on the value of collaborative R&D. We provide recommendations on the optimal contract structure and timing based on two project characteristics, novelty of the R&D process and market-potential variability