Imperfect outsourcing of technological innovations

Many firms outsource innovations from technology entrepreneurs to replenish pipelines and shorten innovation cycle times. By modeling the dynamic incentives and decisions of technology entrepreneurs, this paper studies two potential imperfections arising in this process: adverse selection and moral hazard.

I estimate a model combining contract-design and developmental performance data from the pharmaceutical industry, where large downstream commercializers outsource drug candidates from upstream entrepreneurial biotech innovators.

Results point to the existence of both imperfections, but reveal adverse selection as a much costlier one.

I use these results to illustrate that downstream commercializers that do not account for this problem may commit costly errors in terms of the selection, timing, and number of outsourced technologies. 

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