Think about basic economics — when you specialize in one skill and your neighbor specializes in another, you’re both better off when you collaborate and trade amongst each other, rather than relying on your own advantages.

Firms are increasingly recognizing this principle holds true when it comes to research and development (R&D) information sharing among firms.

Businesses form research and development alliances when developing new products. An R&D alliance is a formal relationship between two or more firms to pursue mutually beneficial goals. The firms remain independent entities, but enter into an agreement to combine their knowledge bases in order to expand and refine innovations. “It’s simple,” says Lorraine Eden, a management professor at Mays Business School. “Two brains are better than one.”

R. Duane Ireland

Michael Hitt

Lorraine Eden

Many industries are involved in R&D alliances, including pharmaceutical, automotive, electronics and chemical companies. When the costs and risks of developing new products are both high, these firms are more likely to enter into an R&D alliance, says Michael Hitt, a University Distinguished Professor in management and Joe B. Foster ’56 Chair in Business Leadership.

Dan Li ’05, now teaching at Indiana University, worked at Texas A&M with Eden, Hitt and R. Duane Ireland, Distinguished Professor in management, Conn Chair in New Ventures Leadership and AMJ Editor, on a recent study to examine which type of governance structure is most effective for these alliances. They focused their research on multilateral alliances (three or more firms) and compared them with bilateral alliances (a joint venture between two firms).

“Very few have studied multilateral alliances,” Hitt said in describing the research’s uniqueness. Eden adds: “People have been researching bilateral firms for the past 20-30 years, but there’s been not much written on multilateral ones.”

Hitt describes information sharing between firms as “a real balancing act.” Individual firms must manage the information they share and the information they protect. “In a joint venture,” says Hitt. “If everyone invests money, there’s an incentive to share information and be fair.” They wanted to learn if this remained true when the number of partners increases.

According to Eden, much of the intended knowledge sharing within the alliances involves “tacit information” — information that must be thoroughly explained and demonstrated by one firm to another. She argues that selecting the type of governance (equity-based or contractual) structure can be critical to the success of the R&D alliance since equity ownership, where one firm owns a piece of the other firms, can help facilitate planned knowledge sharing among them.

At the same time, however, sharing knowledge often leads to “unintended information leakages,” which causes problems among the R&D alliance partners. “There’s a real hesitancy,” Hitt says. “When you’re in an alliance, you have to trust your partners, who are potential competitors, to be fair.”

Their study examined 2,500 alliances — 1,700 bilateral and 750 multilateral. The researchers also compared governance structures in two types of trilateral R&D alliances: chain and net. The study found that 18 percent of trilateral alliances use a chain-based approach, which involves a passing of information from one firm to another, and 82 percent of alliances use net-based approaches, or group sharing.

As the complexity of the alliance increases, the probability of cheating also increases. For example, the alliance between pharmaceutical companies becomes more complex if the companies are from different countries, mainly because intellectual property rights vary internationally. Additionally, the more firms involved in an alliance, the more likely there will be a “free-rider,” or a firm that wants information from other companies without sharing any of its own. This is more likely the case in net than in chain trilateral alliances, notes, Eden, because it is “easier for the cheater to hide.”

The research found that equity governance structures, rather than contractual structures, combat the uncertainty of information-sharing firms face as complexity escalates in multilateral alliances. Equity ownership can help compensate for complexity and free-rider problems, while also helping to facilitate intended knowledge transfers. The greater the emphasis on equity share, the smoother the facilitation and transfer of information, the research notes.

The authors found that, for both knowledge sharing and knowledge protection reasons, firms were more likely to use an equity governance structure in multilateral than in bilateral R&D alliances. Similarly, net trilateral alliances were more likely than chain ones to use equity governance structures.

Eden suggested that the study offers a confirmation for firms interested in governance mechanisms. “Companies will be able to look at the findings and determine what type of governance is best for their alliance.”