SFB 303 Discussion Paper No. A - 153

Author: Leininger, Wolfgang
Title: Patent Competition, Rent Dissipation and the Persistence of Monopoly: The Role of Research Budgets
Abstract: The relationship between market structure and the pattern of innovative R&D-activities has been a prominent research topic in the more recent literature on industrial organization. In particular, the role played by the institution of a patent system in determining an industry market structure has attracted much attention.
The present paper takes up the model of Leininger (1987) and further extends the analysis of the continuous dollar auction game to the general case of different valuations of the object (here: the patent) held by bidders (here: incumbent and entrant). We give a complete and explicit solution (subgame-perfect equilibrium) that shows who wins and how the exact winning bid depends on the order of play and the budgets of the players. This allows an assessment of the role played by research budgets for patent races.
Budgets change with each investment step and thereby determine changing strategic possibilities for the continuation of the patent race. Budgets turn out to be instrumental in our model for both the determination of the winner and the degree of profit dissipation implied by the winning bid of the competition. This suggests that capital market conditions, in particular the access of firms to loans for the financing of R&D, play an important role for the functioning of a 'patent rights'-system. The simple budget constraints presented in our model can be interpreted to reflect financial limitations imposed on firms by capital markets.
One of the more interesting results of our analysis is that the entrant (which by definition holds the lower valuation of the patent) can win the patent and make positive profits after entry.
Creation-Date: January 1988
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