Stage-Gate Incentive Design in Product Development With Resource Competition Among Parallel Projects

Firms often follow the stage-gate process to manage multiple projects in product development and delegate stages of idea discovery and product development to project managers. This framework challenges the firm in designing efficient investment schemes and compensation contracts for the managers due to information asymmetry and resource conflicts among the projects. To address these challenges, we develop a principal-agent model by considering two projects in the presence of asymmetric idea quality information and unobservable development effort. Our results reveal that to incentivize the managers to report truthful idea quality and exert proper development effort, the firm should terminate low-quality ideas even though these ideas can bring positive returns with proper investment. Moreover, as the idea quality decreases, the firm should provide a fixed-salary contract rather than an outcome-based one. The asymmetric idea quality information can create underinvestment inefficiency, and unobservable efforts can exacerbate this inefficiency. We further provide conditions under which encouraging resource competition among parallel projects helps alleviate the underinvestment issue. Overall, our results provide guidelines for designing investment schemes and compensation contracts for parallel research and development (R&D) projects in the presence of moral hazard and adverse selection and shed light on managing the resource competition to improve investment efficiency.