Agency, Entry Threat, and Contract Design: Evidence from R&D Agreements

We examine the design of strategic contracts between a client and an agent when potential entry threats exist, in an incomplete contracting context. Certain contract clauses or rights can be used as strategic tools against entrants. By investigating R&D agreements between pharmaceutical clients and bio-tech agents, we find that strategic contract rights are more likely adopted when potential entry threats from other pharmaceutical firms are larger. Strategic rights and termination rights without cause are also found to be substitutes, with the level of substitution affected by the uncertainty of R&D activities and the previous relationship between contracting parties. We explain the effects of strategic rights and the substitution between strategic rights and termination rights in a general agency model with entry threats.