R&D INSTITUTIONAL ARRANGEMENTS: START-UP VENTURES VERSUS INTERNAL LAB

Why do firms sometimes choose to undertake their R&D by financing start-up companies, while other times they do it in their internal labs? We present a model where the choice of R&D is driven by information asymmetries on the quality of the project between the corporate venture capitalist and the idea owner. In an incomplete information environment, higher-quality projects are more likely to be developed by start-up firms, while low-quality ones are exploited internally. Also, two types of risk are examined, intrinsic quality risk and external shock risk. Riskier project quality and more difficult project monitoring make a project more likely to be developed as a new venture. Finally, the model is able to show why corporate lab scientists get most of their compensation as a fixed salary, while idea owner entrepreneurs working for start-up companies have a profit-sharing agreement. Copyright © 2007 The Authors; Journal compilation © 2007 Blackwell Publishing Ltd and The University of Manchester.