Incentivizing R&D: Prize or subsidies?

► This study characterizes the optimal design of R&D contests. ► This study studies the optimal allocation of a budget between two schemes: an inducement prize and efficiency-enhancing subsidies to the R&D firms. ► In the optimally designed contest, subsidies increase while the prize decreases, if the innovation process is more challenging. ► Sensible conditions are identified under which the optimal contest implements either a “handicapping” scheme (by preferentially subsidizing the “underdog”) or a “national champion” scheme (by favoring the “favorite”).