Issue 2

Volume 12 JOURNAL OF ECONOMICS & MANAGEMENT STRATEGY
Summer 2003

Patents, Invalidity, and the Strategic Transmission of Enabling Information

James J. Anton and Dennis A. Yao
The patent system encourages innovation and knowledge disclosure by providing exclusivity to inventors. Exclusivity is limited, however, because a substantial fraction of patents have some probability of being ruled invalid when challenged in court. The possibility of invalidity—and an ensuing market competition—suggests that when an innovator's capability (e.g., cost of production) is private information, there is potential value to an innovator from signaling strong capability via a disclosure that transfers technical knowledge to a competitor. We model a product-innovation setting in which a valid patent gives market exclusivity and find a unique signaling equilibrium. One might expect that as the probability that a patent will be invalid becomes low, greater disclosure will be induced. We do not find this expectation to be generally supported. Further, even where full disclosure arises in equilibrium, it is only the less capable who make full disclosures. The equilibrium analysis also highlights many of the novel and appealing features of enabling knowledge disclosure signals.

Endogenous Technological Spillovers: Causes and Consequences

Hans Gersbach and Armin Schmutzler
We develop a new approach to endogenizing technological spillovers. We analyze a game in which firms can first invest in cost-reducing R&D, then compete on the human-capital market for their knowledge-bearing employees, and finally enter the product market. If R&D employees change firms, spillovers arise. We show that technological spillovers are most likely when they increase total industry profits. We use this result to show that innovation incentives are usually stronger for endogenous than for exogenous spillovers and that endogenous spillovers may reverse the result that innovation incentives are stronger under quantity competition than under price competition. Finally, we explore the robustness of our results with respect to contractual incompleteness and the number of R&D workers.

Efficient Intercarrier Compensation for Competing Networks When Customers Share the Value of A Call

Patrick Degraba
In competitive telecommunications markets each carrier relies on competing networks to terminate internetwork calls. Regulators typically require the calling party's network to pay a termination fee to the called party's network equal to the terminating network's “incremental cost” of completing the call, effectively imposing all of the costs on the calling party's network. These payments can affect retail prices and therefore consumption. I show that when both parties benefit from a call, they should bear its costs in proportion to the benefit they receive. Therefore, imposing all of the costs of an internetwork call on the calling party's network can be inefficient if these costs are reflected in the calling party's usage rates. A system in which two networks exchange traffic at specified points on a bill-and-keep basis imposes some of the cost on each network, which will then be imposed on the parties. This can generate more efficient network utilization, even with unbalanced traffic between networks. Thus, regulators may improve the efficiency of telecommunications markets by establishing bill-and-keep intercarrier compensation rules.

Backward Integration by a Dominant Firm

Laurent Linnemer
This paper studies the welfare consequences of a vertical merger that raises rivals' costs when downstream competition is a la Cournot between firms with constant asymmetric marginal costs. The main result is that such a vertical merger can nevertheless improve welfare if it involves a downstream firm whose cost is low enough. This is because by raising the input price paid by the nonmerging firms the merger shifts production away from those relatively inefficient producers in favor of the more efficient firm. Yet, there is a trade-off between the gain in productive efficiency and the loss in consumers' surplus caused by the higher downstream price that follows a higher input price. It is also shown, through an example, that this result extends to price competition with differentiated products.

Downstream Competition, Foreclosure, and Vertical Integration

Gilles Chemla
This paper analyzes the effect of competition among downstream firms on an upstream firm's payoff and on its incentive to integrate vertically when firms in both segments negotiate optimal contracts. We argue that as downstream competition becomes more intense, the upstream firm obtains a larger share of a smaller downstream industry profit. The upstream firm may encourage downstream competition (even excessively) in response to high downstream bargaining power. The option of vertical integration may be a barrier to entry downstream and may trigger strategic horizontal spinoffs or mergers. We extend the analysis to upstream competition.