Pairing provision price and default remedy: optimal two‐stage procurement with private R&D efficiency

This article studies cost‐minimizing two‐stage procurement with Research and Development (R&D). The principal wishes to procure a product from an agent. At the first stage, the agent can conduct R&D to discover a more cost‐efficient production technology. First‐stage R&D efficiency and effort and the realized second‐stage production cost are the agent's private information. The optimal two‐stage mechanism is implemented by a menu of single‐stage contracts, each specifying a fixed provision price and remedy paid by a defaulting agent. A higher delivery price is paired with a higher default remedy, and a more efficient type opts for a higher price and higher remedy.