The Role of Decision Rights in Co-Development Initiatives

We study initiatives for novel co-development projects, where it may be difficult a priori to specify contracts contingent on the project outcome. In such settings, firms often rely on simple contracts that specify the decision-making process by allocating decision rights. Our goal is to study the effectiveness and design of such governance structures in incentivizing co-operative efforts and maximizing the total value of the project. In our model, a seller and a buyer consider a menu of non-contingent contracts, each of which specify a quantity and an associated transfer payment. The contracts also specify decision rights to set the contract terms upfront (ex-ante) and to choose the quantity after the market potential is realized (ex-post). Our results bear several important implications for the optimal allocation of decision rights and the value of contracting: First, when a decision right is delegated to the seller, he exerts higher effort towards the project. However, the seller may exert lower effort when he has both the decision rights as opposed to when he only has the ex-post decision right. Second, when the buyer has low bargaining power, the ex-post decision right should be delegated to the seller, i.e., the party with lower exposure to the effort-contingent outcome. Otherwise, the ex-post decision right should be delegated to the buyer but the ex-ante right should be held by the seller. Finally, we show that simple contracts with decision rights outperform a spot contract when the ex-post bargaining power of one of the parties is substantially higher.