Exclusive Versus Non-Exclusive Licensing Strategies and Moral Hazard

Abstract

A patentee has invented a new technology. There are two downstream firms that might successfully develop a marketable product based on the new technology. The probability with which a downstream firm is successful in developing the product depends on its effort level. There are situations in which two licenses are sold if effort is a hidden action, while one exclusive license is provided if effort is verifiable. Moral hazard may thus increase the probability that the product will be developed. Methodologically, the concept of "virtual costs" is used in a moral hazard framework, demonstrating the analogy to adverse selection models.