Monitoring or Disclosure? The Role of Observability in Collaborative Projects

Abstract

Many projects (such as innovation and new product development) often involve tight collaboration among several firms. The success of such initiatives depends on all firms committing resources and generating high quality outputs. We consider a setting with two firms engaging in a collaborative project and study two mechanisms by which one of the firms can increase the output observability in order to coordinate in both firms delivering high quality: monitoring the other firm's progress or disclosing her own progress to the other firm. We first develop normative predictions using game-theoretic models and find that when the project value is intermediate, a firm should choose monitoring; when the project value is high, she should be indifferent between monitoring and disclosure. To test the normative prediction, we conducted a laboratory experiment. We find that firms mostly choose monitoring regardless of the project value. However, choosing disclosure does not necessarily lead to a lower profit for a firm. In fact, when the project value is high, choosing disclosure has a higher profit potential than monitoring. This is due to a framing effect: the partner firm – who observes the progress of the firm who chooses to disclose – is willing to choose a higher quality. Overall, disclosure leads to higher profits for the partner firm, and is preferred by firms who are intrinsically surplus maximizers. This implies profitable opportunities for firms if they have a chance to choose the more open firms (who are prone to disclose their progress) as their project partners, ceteris paribus.