Optimal Patent Strength under Financial Constraints

Abstract

This paper analyzes how the optimal strength of patents on basic inventions is affected by financial constraints on the side of either inventors or developers. The lower the net wealth of a developer is, the more difficult it becomes for an inventor to license her invention to him as she has to rely more heavily on royalties that are only paid in the case of success and discourage the developer from exerting costly effort. Because of this, the distortions arising from patents on inventions are larger if more developers are financially constrained and it is optimal to reduce patent protection in this case. If the inventor is financially constrained, it is, however, optimal to grant stronger patent protection as inventions become more costly due to additional agency costs.

Keywords: optimal patent strength, financial constraints, licensing, innovation

JEL Classification: O34, O31, O32, L24, D23