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An Option-Based View of Imperfect Patent Protection

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Author Info
Philipp N. Baecker () (Department of Finance and Accounting, EUROPEAN BUSINESS SCHOOL (ebs), International University Schloß Reichartshausen)

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Abstract

Given a noticeable degradation of patent quality, patenting has come to resemble the purchase of a lottery ticket. Rising cost of engaging in litigation over intellectual property (IP) assets substantially diminishes their value as an incentive to invest in research (Lanjouw and Schankerman, 2001). The author proposes an option-based view (OBV) of imperfect patent protection as a formal strategic model of so-called probabilistic patents (Lemley and Shapiro, 2005), which may serve as a starting point for further investigations into the impact of patent risk on firm values and research incentives. More specifically, the real option approach is employed to demonstrate how, due to increased litigation activity in red oceans, rising profit rates may lead to falling patent values, calling for a careful tradeoff between reliable patent protection in mature markets and seemingly attractive business opportunities in industries such as pharmaceutical biotechnology.

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Publisher Info
Paper provided by Department of Finance and Accounting, EUROPEAN BUSINESS SCHOOL (ebs), International University Schloß Reichartshausen in its series ebs Working Papers on Finance and Accounting with number 060601.

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Length: 37 pages
Date of creation: 23 Jun 2006
Date of revision: 10 Jan 2007
Handle: RePEc:ebs:finacc:060601

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Related research
Keywords: capital budgeting; intellectual property; litigation; real options;

Find related papers by JEL classification:
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
O31 - Economic Development, Technological Change, and Growth - - Technological Change - - - Innovation and Invention: Processes and Incentives
C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games

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References listed on IDEAS
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  1. Lanjouw, Jean O & Schankerman, Mark, 2001. "Characteristics of Patent Litigation: A Window on Competition," RAND Journal of Economics, The RAND Corporation, vol. 32(1), pages 129-51, Spring.
  2. Dickey, David A & Fuller, Wayne A, 1981. "Likelihood Ratio Statistics for Autoregressive Time Series with a Unit Root," Econometrica, Econometric Society, vol. 49(4), pages 1057-72, June. [Downloadable!] (restricted)
  3. Longstaff, Francis A & Schwartz, Eduardo S, 2001. "Valuing American Options by Simulation: A Simple Least-Squares Approach," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 14(1), pages 113-47.
  4. Mark A. Lemley & Carl Shapiro, 2005. "Probabilistic Patents," Journal of Economic Perspectives, American Economic Association, vol. 19(2), pages 75-98, Spring. [Downloadable!] (restricted)
  5. Lucian Arye Bebchuk, 1984. "Litigation and Settlement under Imperfect Information," RAND Journal of Economics, The RAND Corporation, vol. 15(3), pages 404-415, Autumn. [Downloadable!] (restricted)
  6. Crampes, Claude & Langinier, Corinne, 2002. "Litigation and Settlement in Patent Infringement Cases," Staff General Research Papers 5231, Iowa State University, Department of Economics.
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  7. Eduardo S. Schwartz, 2004. "Patents and R&D as Real Options," Economic Notes, Banca Monte dei Paschi di Siena SpA, vol. 33(1), pages 23-54, 02. [Downloadable!] (restricted)
  8. Carl Shapiro, 2003. "Antitrust Limits to Patent Settlements," Law and Economics 0303004, EconWPA. [Downloadable!]
    Other versions:
  9. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June. [Downloadable!] (restricted)
  10. Harrison, J. Michael & Kreps, David M., 1979. "Martingales and arbitrage in multiperiod securities markets," Journal of Economic Theory, Elsevier, vol. 20(3), pages 381-408, June. [Downloadable!] (restricted)
  11. Reiko Aoki & Jin-Li Hu, 2003. "Time Factors of Patent Litigation and Licensing," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 159(2), pages 280-, June.
  12. Trigeorgis, Lenos, 1991. "A Log-Transformed Binomial Numerical Analysis Method for Valuing Complex Multi-Option Investments," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(03), pages 309-326, September. [Downloadable!]
  13. Marco, Alan C., 2005. "The option value of patent litigation: Theory and evidence," Review of Financial Economics, Elsevier, vol. 14(3-4), pages 323-351. [Downloadable!] (restricted)
    Other versions:
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