This paper develops an incomplete contract model of the licensing relationship that is susceptible to the moral hazard problem. The optimal contractual form of licensing derived in the model generates predictions that seem to be consistent with actual practice. For instance, the introduction of inputs that are not contractible and costly explains the prevalence of royalty contracts in the licensing relationship. Moreover, the model is able to relate the size of the royalty rate to the parameters that represent the environments under which the concerned parties operate. Finally, the model can be naturally extended to analyze the choice of a technology holder between direct investment and licensing in an attempt to serve a foreign market.
Bibliographical noteFunding Information:
I am grateful to Oliver Hart, Kate Rockett, Robert Staiger, and two anonymous referees for their constructive comments and advice. The preliminary draft of this paper was written while I was visiting the Center for Economic Studies, University of Munich and the Institute for Advanced Studies in Vienna, Austria. I thank these two institutions for their hospitality during my stay. The financial support for this research was partly provided by the Social Science Research Council through the Abe Fellowship Program and the Austrian Ministry of Science and Research.
All Science Journal Classification (ASJC) codes
- Industrial relations
- Aerospace Engineering
- Economics and Econometrics
- Economics, Econometrics and Finance (miscellaneous)
- Strategy and Management
- Industrial and Manufacturing Engineering