UCL School of Management is delighted to welcome Pascale Crama, Singapore Management University, to host a research seminar discussing ‘Turning the tables; Licensing contracts with reciprocal options.’
Research and development (R&D) collaborations are often signed when one or both parties lack capabilities to successfully bring the product to market on their own, and joint efforts from both partners are needed to create value. The uncertain nature of R&D, however, complicates the monitoring of the efforts contributed to the collaboration, thus potentially reducing the collaboration’s value because of moral hazard. We investigate how either party’s attempt to acquire the previously missing capability – possibly at a lower level or even at parity with her partner – before or during the course of the collaboration affects the value created. We focus on contracts with buyout and/or buyback options, as well as a novel combination of buyout and buyback option in which the strike price is determined ex-post and the option can be reciprocated by the offeree. We find that the cost of effort to achieve the missing capability and variability in the outcome of the capability building effort determines whether the optimal strategy is to delay licensing until after the capability building has been attempted – but failed – or whether signing a licensing contract before capability development offers greater value. We define the optimal contract terms under each contract type and provide recommendations on the optimal contract type based on the cost and outcome variability of capability building, as well as the value loss from moral hazard.