Control Rights over IP

Corporate Venturing

and

Bankruptcy Regimes

Context: Cumulative R&D with Licensing of Interim Knowledge

• Glaxo, Smith, Kline: 40% of Expected Sale from Developing Outsourced Drug Ideas cf

• Pfeizer, without such a pipeline, for which

• WAS IT important that GSK participated to a greater extent in Corporate Venturing, of say Biotech start-ups, assigning GSK first right of refusal on licensing their innovation

• If so, through what Specific Control Rights

Given Inalienability of RU’s IPR

• Which Implies that a (controlling) DU only has this right of first refusal, but NOT that of appropriating the RU’s IP, ex interim, cf

• As Aghion and Tirole, QJE 1994 assume!!

• Plausible sources of such advantage are:

• Prior Claim to Trade Secret Based License

• More subtly, impact of Restricting Coalition Formation with Third Parties on Sharing of

And Choice over Licensing Mode

• Surplus from and Choice over Patented vs Trade Secret Based Knowledge Licensing

• Former allows precommitment to exclusive knowledge transfer, at the cost of leakage of non-codifiable aspects to non-licensees

• Latter requires non-lumpsum licensing fee,

to prevent RU from selling her idea to third parties, competing Development Unit DUs

Knowledge Licensing Model

• At time t= 0, RU puts in privately observed costly effort e, which results randomly at

• Time t= 1- in a Knowledge level K in [0, 1], its maximum probability of development as

• Marketable Product of Appropriable Value V, if and only if Developer Succeeds Alone

• At t = 1, RU chooses, modulo a Controlling DU’s first Refusal right, its Licensing Mode

Using Trade Secret, or Patent

• In Trade Secret or Closed mode, Licensor and Licensee Bargain over Structure cum Level of Licensee Fee, AFTER the contour of the idea, communicative of the level of K but not its full content, is provided to DU

• In Patent mode RU and DUs (sequentially) Make Licensing Offers and Counteroffers: Rejection of Counteroffer of one DU leads to RU making her next offer to Other DU

Which Differ Contractually As

• Since Patent Records Codifiable Aspects of K, Licensing Fee is a Lumpsum Amount Fo

• But, knowledge level L*K leaks to the NON- Licensee DU as well

• Then at t = 1+, both DU’s choose Efforts Ei/j for Development

• With a Trade Secret- Based Licensing of Knowledge K, RU has

• Moral Hazard w.r.t. a Clandestine Sale of K to the Other DU also,

• To mitigate against a Deviating second sale

RU gets a Contingent Share s in a Licensee

Payoffs in Development Stage

• For a Licensee DU is Max{P(1-Q) - C(P; K)} P

• For Non-Licensee DU

Max{Q(1-P)-C(Q;LK)}

Q

Where C(X;Y) is strictly increasing & convex in X, single-crossing/ decreasing vis-à-vis Y

• Licensee DU chooses its P = Pc to maximize {P(1-s) – C(P,K)}, and

• s(K;L) is the Incentive Compatible Revenue Share of RU, chosen

• To satisfy No Resale to Other DU Condition

• s(K;L)*{Pc-Pc(1-Pd)}> [{Pd(1-Pc) -C(Pd;K)} -

Lead to the Equilibrium Payoffs

• [To(Po;K) - Fo] for the Licensee DU, same as [To(Qo;LK)] for the Non-licensee, where

• {Po,Qo} are arrived at as Nash Equilibrium choices in the contest for development, post

• Exclusive Licensing of Content of K to a DU

{Qd(1-Pc)-C(Qd;LK)}]

* [Tc(Pc;K)-s(K;L)Pc-Fc]

for the Licensee DU and

[s(K;L)Pc+Fc] to the RU

where Fc +/- is a Lump

Sum to/from RU at t =1;

s(K;L) is decreasing in

{K, L}; Joint Surplus Tc

increases in both {K, L}

With the Characteristics that

For o-mode Licensing of K

• To is increasing in K, and decreasing in L, so that it is preferred to the c-mode for low levels of Leakage L and, as it turns out, for lower levels of K, given L

• Po(K;L) is increasing in K, but Qo(K;L) initially goes up then decreases with K, making Tc < To, higher K

Whereas c-mode License

• That’s IC for Exclusivity may NOT exist, for low {L, K} but when it does

• Even [s(K;L)*Pc(K;L)] is strictly decreasing in K so

• An (RU’s) Interim Wealth Constraint Needing Fc >0 May Bind only for Low K, when {s(K;L), Fc} satisfy Nash with Outside Option

Imply that the Licensee DU May

• Prefer O-mode Licensing of K Following it being Patented, by its wealth constrained Licensee RU even when To(K;L) < Tc(K;L)

• If given the level of leakage L thus caused [To(K;L)-Fo] > [{1-s(K;L)}*Pc(K;L)-C(Pc;K)]

• If RU is independent(ly financed ex ante) it can, we assume, approach its VC financier to advance any Fc < 0, required to be paid to Licensee DU for her to Agree to c-Mode

Force Interim Inefficient Choice of the Licensing Mode on RU

• For a RU Controlled by its Licensee (to be) DU, via an ex ante (t=0 agreed) Corporate Venture Contract, which Prohibits the RU Contingent Revenue Sharing Contracts vis

-a-vis any Third Party until Controlling DU exercises her right of first refusal, such an

Interim Recourse to an Independent VC is Infeasible; Unformed Legal Entity Can Not Promise DU a Legally Binding Fc Contract

To Reduce RUs Payoff When It

• Produces Low Level of Interim Knowledge K, compared to that to an Independent VC

Financed RU, thus Incentivizing it Ex Ante to Expend Costlier Effort e (attempting) to Produce Higher Interim Knowledge Levels

Such a Interim-Inefficient DU Control Right Constraining “its” RU, in forming Coalitions Prior to Bargaining over a Licensing Mode Choice, May Remain Renegotiation-Proof!

Our Earlier Work Has Modeled

• This tradeoff for differing interim innovative knowledge levels, leakages resulting from descriptions thereof, without delving into

• How a Control right of a Downstream DU over its sponsored RU may affect Tradeoff

• With potential impact on the RU’s ex ante Research Incentive, to Generate Research Ideas with Higher Development Likelihood

Here, RU’s Wealth Constraint is

• Important for its Ability to Influence Choice over the Interim Licensing Mode, because

• When the Optimal Choice is Trade Secret based, RU’s required Revenue share may imply IT making a positive interim Transfer to its licensee DU, to prevent IT preferring licensing post-patenting, if leakage of RU’s knowledge from it is high enough, thereby lowering RU’s Open-mode Licensing Fee

Binding for Lesser Innovations

• Precluding Financial Coalition Formation w Third (VC) Parties at Interim Stage Leads to RU being more severely Penalized if it generates lesser Innovations, which she’d have to Patent, unlike the more Promising

• Can such Control Rights, which lowers the RU & DU interim surplus for lower (likely to develop) innovations, survive an ex Interim

Renegotiation- Proofness Norm

• The Answer is Yes, since any Coalition of an RU with a Potential Third-Party Partner, who’d advance her moneys to pay her DU to persuade him to cede them the requisite revenue share for trade secret-based sale of her interim knowledge, CAN NOT make a legally binding promise/contract to pay a DU more than the maximum of (i) a Nash- like split, and (ii) his Outside Option payoff

In Contrast, when Alternative

• Interim Knowledge Levels represent Multi- Faceted Potential Applications of the Core Interim Innovative Idea, then even if First Development effort Fails, maximizing the Licensing fee for an Alternative Application may enhance both the interim Liquidation Value, as well as ex ante research efforts

• Different (“Old vs New Economy”) Sectors are Likely to Differ on these Dimensions of

Main Empirical Implications

• Multi-facetedness of Innovative Ideas, cf ex ante costliness of (directed) research efforts, needed to generate these, so that:

• In more Traditional Sectors, Tough Control mechanisms such as Corporate Venturing may matter more ex ante, whereas in the

• New Economy Sectors, Softer Bankruptcy Regimes, allowing Debtor-in-Possession Finance, may Improve Research Incentive

In Context of Cumulative R&D

• Corporate Venturing May Matter Because it Enables the Controlling DU to Lower the Payoff to Its Controlled RU Selectively, at Lower Knowledge levels, by Influencing RU’s Interim Choice of Mode of Licensing

• Resulting in Greater, and Overall Surplus- Enhancing, Effort Exertion ex ante by RU

• Indeed, as a result we may even Observe More Patenting (o-mode licensing) by RUs