INCOMPLETE CONTRACTING AND THE STRUCTURE OF R&D JOINT VENTURE CONTRACTS

• DOI: https://doi.org/10.1016/S1048-4736(04)01506-1
• Pages: 201-228
• Date: 27 April 2004
• Published date: 27 April 2004
• Author: Suzanne E. Majewski,Dean V. Williamson

INCOMPLETE CONTRACTING

AND THE STRUCTURE OF R&D

JOINT VENTURE CONTRACTS

Suzanne E. Majewski and Dean V. Williamson

ABSTRACT

There is a tension between the literatures on incomplete contracting and

transactions cost economics regarding the importance of ex post governance

and the extent to which formal theories of incomplete contracting capture

salient aspects of exchange relations. In this paper, we empirically examine

how firms structure joint R&D agreements to illuminate how contracts can

be incomplete and how governance can matter. We employ a dataset of 96

contracts to construct a taxonomy of the types of mechanisms firms use in

organizing collaborative R&D, and indicate how groups of mechanisms

line up with various types of contracting hazards. The results suggest that

the allocation of property rights over innovations at the time of contracting

between R&D partners is an important aspect of contract design. But they

also suggest that weak property rights admit scope for other dimensions

of contract. In particular, the research indicates that while knowledge

spillovers may give rise to appropriability hazards, efforts to contain or

channel knowledge spillovers may enable joint venture members to strategi-

cally block other members’ follow-on commercialization or research. Firms

Intellectual Property and Entrepreneurship

Advances in the Study of Entrepreneurship, Innovation and Economic Growth,

Volume15, 201–228

Copyright © 2004 by Elsevier Ltd.

All rights of reproduction in any form reserved

ISSN: 1048-4736/doi:10.1016/S1048-4736(04)01506-1

201

202 SUZANNE E. MAJEWSKI AND DEAN V.WILLIAMSON

design joint R&D governance mechanisms to balance spillover hazards and

strategic blocking.

1. INTRODUCTION

How do parties to complex exchange craft their exchange relations to enable

adaptations to unforeseen contingencies? This question might seem innocuous,

but it is loaded with concepts that have motivated diverse lines of research

relating to the design of governance structures. What do we mean by “exchange

relations” and “unforeseen contingencies,” and how might firms design contracts

to accommodate the problem of adapting exchange relations to unforeseen

contingencies?

These are questions that have been taken up in literatures that relate to the more

general issue of incomplete contracting. These literatures have made progress

toward characterizing how contracts can be incomplete, and they have made

progress toward sorting out how the incompleteness of contracts, both exogenous

and endogenous, can inform the design of governance structures. But tricky issues

remain, only one of which we will focus on here. We focus on howweak property

rights can motivate incompleteness and how weak property rights can frustrate

solutions to hold-up that theories of incomplete contracting suggest. Specifically,

literatures on incomplete contracting have suggested that much of the action in

contract design relates to hold-up problems, and these literatures have suggested

ways in which judiciously allocating property rights can remedy hold-up. Con-

tracting problems involving collaborative R&D may also feature hold-up, but a

salient aspect of R&D is that it involvesenvironments in which property rights – in

this case intellectual property rights – can be weak. Weak property rights, it turns

out, provide scope for strategic behaviors that have some of the flavor of hold-up

but yet remain beyond the scope of formal theories of incomplete contracting.

And that is not all. Weak property rights provide scope for a class of remedies not

anticipated by formal theory.

Weak property rights manifest themselves in at least two ways. First, weak

property rights can frustrate the efforts of parties to appropriate rents. For example,

informational externalities or knowledge spillovers might preventfirms from fully

appropriating the returns to R&D. Appropriability can be an interesting problem

in contexts, such as those involving R&D, in which parties must sink investments,

because difficulties in appropriating rents may diminish incentives to invest in

the first place (Spence, 1984). Second, weak property rights are conspicuously

manifested in the ways parties manipulate legal processes to extract rents. The

most obvious example is patent litigation. A patent endows a patent holder