R&D Institutional Arrangements: Start‐Up Ventures Versus Internal Lab

Why do firms sometimes choose to undertake their R&D by financing start‐up companies, while other times they do it in their internal labs? We present a model where the choice of R&D is driven by information asymmetries on the quality of the project between the corporate venture capitalist and the idea owner. In an incomplete information environment, higher‐quality projects are more likely to be developed by start‐up firms, while low‐quality ones are exploited internally. Also, two types of risk are examined, intrinsic quality risk and external shock risk. Riskier project quality and more difficult project monitoring make a project more likely to be developed as a new venture. Finally, the model is able to show why corporate lab scientists get most of their compensation as a fixed salary, while idea owner entrepreneurs working for start‐up companies have a profit‐sharing agreement.