Does Banning Side Payments in Patent Settlements Suffice to Fully Protect Consumers?

By using a simple model of patent settlement, in this paper we show that even if side payments (negative fixed fees) are banned, a licensing agreement to settle a patent dispute may harm consumers in comparison with the expected outcome of the lawsuit. This may occur when the challenger’s expected return from litigation is low, that is when probabilistic damages are high relative to the challenger’s duopoly profits. Our model suggests that: (1) there may be large benefits to consumers from post-grant reexamination of commercially valuable patents -as stressed by Farrell and Shapiro (2008) in another context; and (2) the threat of punitive damages for patent infringement may harm consumers in the short run, perhaps without being of any help in providing the right incentive to innovate.