How to Motivate Innovation : Subsidies or Prizes ?

This paper investigates the optimal design of research contests. A “principal”, who values an innovative technology, attempts to speed up the discovery. In order to minimize the expected amount of innovation time required, the principal decides how to allocate the …xed budget between a top-up prize (e.g. a procurement contract) and e¢ ciency-enhancing subsidies (e.g. research grants) to competing R&D …rms. Our paper shows that although both subsidies and prize incentives facilitate success, their functions di¤er subtly and the ability of one to substitute the other is limited. The main results are as follows. Firstly, the optimal contest preferentially subsidizes the ex ante less e¢ cient …rm. Secondly, more resources are devoted to research subsidies when the private bene…t of the innovation to the successful innovator increases. Finally, more resources are allocated as subsidies when the innovation process involves more uncertainty. JEL Nos: C7, D7, J3