Abstract

We consider patent licensing under a simple model of asymmetric information, where an outsider innovator of a cost-reducing innovation interacts with a monopolist, whose cost is private information. When the innovator is endowed with combinations of fixed fee and royalty, in any optimal menu, the low-cost monopolist is always offered a pure fixed fee contract, while for the contract offered to the high-cost monopolist, the royalty rate is always positive. Moreover, there are cases where it is a pure royalty contract. This provides an explanation of royalty licensing, in particular, and the coexistence of different licensing schemes, in general.

Keywords: Licensing; Cost-reducing innovation; Fixed fee plus royalty; Asymmetric information; Individual rationality; Incentive compatibility

JEL classification: D45; D82