Research Seminars

Incentives for Complex R&D Projects

Speaker: Raul O. CHAO
University of Virginia, Darden School of Business

29 March 2012 - Class room H011 - From 2.30 PM to 4.30 PM

R&D projects are critical to innovation and growth, but are often plagued by organizational and project challenges. The organization hierarchy makes it difficult to manage R&D projects because knowledge and development effort needed to deliver project value are decentralized from managerial authority. Making matters worse, complexity in R&D projects often arises from interactions between the attributes that determine a project’s potential value. In light of these challenges, how should the firm structure incentives to ensure that managers reveal the true potential of a project and invest adequate resources to create value? Leading economic models of R&D often consider agency or complexity, but not both. In this paper, we develop a model that shows how an idea that emerges from search on a complex landscape is intimately tied to an agency problem of adverse selection and moral hazard. Our results show that incentives depend on both the mode of search employed in an organization as well as the complexity of the project. When organizations employ local search (exploitation), incentives should be set higher the more complex is the project. Conversely, when organizations employ distant search (exploration), incentives should be set lower the more complex is the project. The reason for this difference is the distribution of idea quality resulting from local or distant search on a complex landscape.

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