Explaining Organizational Diseconomies of Scale in R&D: Agency Problems and the Allocation of Engineering Talent, Ideas, and Effort by Firm Size

The comparative efficiency and success of small firms in R&D remains largely unexplained. This paper empirically examines scale diseconomies in offering employment contracts as an explanation for diseconomies of scale in R&D. The paper argues that small firms more efficiently resolve the severe agency problems of hidden information and hidden behavior in R&D. Small firms more efficiently offer contracts that reward performance than large firms, and consequently, small firms attract and retain engineers with higher ability and skill. Further, small firms through these more performance-contingent contracts induce higher levels of effort than large firms. The study tests and generally confirms these hypotheses using data collected from 912 current and former engineering employees of two large high-technology companies.