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Milestone Payments Or Royalties? Contract Design For R&D Licensing, Pascale Crama, Bert De Reyck, Zeger Degraeve
Milestone Payments Or Royalties? Contract Design For R&D Licensing, Pascale Crama, Bert De Reyck, Zeger Degraeve
Zeger Degraeve
We study how innovators can optimally design licensing contracts when there is incomplete information on the licensee's valuation of the innovation, and limited control over the licensee's development efforts. A licensing contract typically contains an up-front payment, milestone payments at successful completion of a project phase, and royalties on sales. We use principal-agent models to formulate the licensor's contracting problem, and we find that under adverse selection, the optimal contract structure changes with the licensee's valuation of the innovation. As the licensee's valuation increases, the licensor's optimal level of involvement in the development-directly or through royalties-should decrease. Only a risk-averse …