Optimal design of research contests

Procurement of an innovation often requires substantial effort by potential suppliers. Motivating effort may be difficult if the level of effort and quality of the resulting innovation are unverifiable, if innovators cannot benefit directly by marketing their innovations, and if the buyer cannot extract up-front payments from suppliers. We study the use of contests to procure an innovation in such an environment. An auction in which two suppliers are invited to innovate and then bid their prizes is optimal in a large class of contests. If contestants are asymmetric, it is optimal to handicap the most efficient one.