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Optimal Rules for Patent Races



patentraceapril15.dvi Optimal Rules for Patent Races∗ Kenneth L. Judd Hoover Institution Stanford University [email protected] Karl Schmedders Kellogg School of Management Northwestern University [email protected] S¸evin Yeltekin Kellogg School of Management Northwestern University [email protected] April 18, 2002 Abstract There are two important rules in a patent race: what an innovator must accomplish to receive the patent and the allocation of the benefits that flow from the innovation. Most patent races end before R&D is completed and the prize to the innovator is often less than the social benefit of the innovation. We derive the optimal combination of prize and minimal accomplishment necessary to obtain a patent for a dynamic multi-stage innovation race. Competing firms are assumed to possess perfect information about each others’ innovation state and cost structures. A planner, who cannot distinguish between the firms, chooses the innovation stage at which the patent is awarded and the magnitude of the prize to the winner. We examine both social surplus and consumer surplus maximizing patent race rules. A key consideration is the efficiency costs of transfers and of monopoly power to the patentholder. If efficiency costs are low and the planner maximizes social surplus, then races are undesirable. However, as efficiency costs of transfers associated with the patent rise, the optimal prize is reduced and the optimal policy spurs innovative effort through a race of nontrivial duration. Races are also used to filter out inferior innovators since a long race (i.e. a high minimal accomplishment requirement) in innovation makes it less likely for an inefficient firm to win through random luck. In general, races do serve to spur innovation. ∗The authors are grateful to Mort Kamien, Ariel Pakes, Mark Satterthwaite, Christopher Sleet, and seminar audi- ences at Stanford University, MIT, Harvard University

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