Licensing Process Innovations when Losers’ Messages Determine Royalty Rates

Abstract

We consider a licensing mechanism for process innovations that awards a limited number of fixed-fee licenses to those firms that report the highest cost reductions, combined with royalty licenses to others. Firms' messages are dual signals: the message of those who win a fixed-fee license signals their cost reduction to rival firms, whereas losers' message influence the royalty rate set by the innovator. We derive conditions for existence of a truth-telling equilibrium, explain why a sufficiently high reserve price is essential for such an equilibrium, and show that the innovator generally benefits from the proposed mechanism.

Keywords: Patents, licensing, auctions, royalty, innovation, R&D, mechanism design

JEL Classification: D21, D43, D44, D45