We model technical innovation of a final good at the subcomponentlevel. Research and Development efforts are undertaken onsubcomponents, incrementally enhancing the technological inputs tothe final good. Through observation of actual R and D procurements,we identify the principal and agents appropriate for such innovation.Two categories of agent, the conventional profit seeking agent and aperformance seeking agent, are identified. A principal who jointlyvalues the capabilities of the subcomponent undergoing R and D andthe funds available for purchasing other subcomponents to the finalgood is identified. The principal does not have a transferable utilityfunction. We characterize optimal R and D production organizationbetween such a principal and each type of agent. In addition to theimportance of the information environment between principal andagent, the motivational properties of the principal and agentsignificantly affect the form and existence of optimal R and Dprocurement. We draw insights for both private and public sectorindustrial organization.
