Indemnification, Monitoring, and Competition: Evidence from R&D Contracts

Guo, Di; Hua, Xinyu; Jiang, Kun

Abstract

This article examines the adoption of indemnification clauses in research and development (R&D) contracts, in which a firm commits to reimbursing its agent against liabilities and legal costs. Indemnification achieves efficient risk sharing but dilutes the agent's incentives to take precautions. Such incentives may be restored if the firm offers contingent indemnification and monitors the agent's activities. Additionally, tougher competition can motivate the firm and agent to take more aggressive R&D activities, which leads to higher liability risks. We show that the optimal contract is more likely to include an indemnification clause when monitoring is more effective and market competition is tougher. By investigating R&D agreements between pharmaceutical firms and biotech agents, we find relevant empirical observations. We also observe a positive correlation between the use of indemnification clauses and the use of termination rights that allow firms to terminate projects without cause.

Citation

Guo, D., Hua, X., & Jiang, K. (2022). Indemnification, Monitoring, and Competition: Evidence from R&D Contracts. American Law and Economics Review, 24(1), 203-246. https://doi.org/10.1093/aler/ahac004

• Journal Article Type: Article
• Acceptance Date: Apr 9, 2022
• Online Publication Date: May 31, 2022
• Publication Date: May 31, 2022
• Deposit Date: Apr 21, 2022
• Publicly Available Date: Jun 1, 2024
• Journal: American Law and Economics Review
• Print ISSN: 1465-7252
• Electronic ISSN: 1465-7260
• Publisher: Oxford University Press
• Peer Reviewed: Peer Reviewed
• Volume: 24
• Issue: 1
• Pages: 203-246
• DOI: https://doi.org/10.1093/aler/ahac004
• Keywords: Law; Finance
• Public URL: https://nottingham-repository.worktribe.com/output/7784259
• Publisher URL: https://academic.oup.com/aler/article-abstract/24/1/203/6597120
• Additional Information: This is a pre-copyedited, author-produced version of an article accepted for publication in American Law and Economics Review following peer review. The version of record Di Guo, Xinyu Hua, Kun Jiang, Indemnification, Monitoring, and Competition: Evidence from R&D Contracts, American Law and Economics Review, Volume 24, Issue 1, Spring 2022, Pages 203–246, is available online at: https://doi.org/10.1093/aler/ahac004