Bilateral Moral Hazard for R&D and Advertising in Vertical Structure

In vertical industrial structure, moral hazard problem occurs either in upstream or downstream sectors. For example, for any wholesale price, the manufacturer do not internalize the externalities of his R&D investment. Then, the manufacturer provides too little innovation. This problem can also be applied to (downstream) promotional effort. The retailer causes the market demand to be small. Holmström (1982) suggest a marginal source (third party), which partially solves the multilateral moral hazard problem. In this paper, we search other instruments that can solve these problems, such as cooperative advertising or two-part tariff.