A Transactions Cost Theory of Patent Law

Abstract:     
In 1982, the Federal Circuit Court of Appeals was established, and shortly thereafter, patent validity rates climbed dramatically. Not surprisingly, the rate of patenting also increased, tracking the rising validity rate. To the surprise of patent incentive theorists, however, research and development expenditures fell in relation to the patenting rate throughout the 1980's, prompting one prominent commentator to conclude, "the incentive story as classically told has some serious problems." In response, this essay describes critically important purposes served by patent law beyond providing incentives for inventors and innovators. In particular, patent ownership rules significantly reduce transaction costs compared to the available alternative system for protection: trade secrecy. Several ways that patent law lowers transaction costs have already been identified by commentators, but new scholarship in the area of corporate law finally makes possible the assertion that the transaction cost rationale is of primary importance. Theorists of the firm have long sought to explain the law of business organizations as providing legal structures in situations where contractual solutions are likely to be too costly. Similarly, the patent form can be characterized as a legal structure designed to reduce costs associated with the alternative regime of trade secrecy. Critical in this regard is recent groundbreaking work by corporate law scholars who have de-emphasized the role of limited shareholder liability and agency costs in the development of the corporate form. Instead, recent scholarship describes the corporation primarily as a superior response to: (i) The need to shield the assets of an enterprise from the creditors and heirs of those who invest in it ("affirmative asset partitioning"), and (ii) The need to monitor shirking and opportunistic behavior when the relative value of inputs and outputs of an enterprise are difficult to measure ("team production problems"). Important features of patent law, and the behavior of patentees, can be explained as responses to these same concerns.

Keywords: patents, Hall, Ziedonis, Levin, Scherer, Kortmer, incentives, asset partitioning, team production, monitoring, opportunistic behavior, Long, Kitch, theory, transaction costs, information costs, corporation, theory of the firm, Alchian, economics

JEL Classifications: K11, K20, K30, L20, L22

Working Paper Series