Lurking Patent Claims and Strategic Royalty Contracts

ABSTRACT This paper analyzes optimal licensing contracts when a licensee faces the risk of future infringement claims by unknown patent holders. In a setting where a noncompeting licensor contracts with a monopolistic manufacturer, fixed‐fee licensing is optimal absent such claims. We show that the possibility of future patent claims makes it optimal to include a per‐unit royalty. The royalty reduces the surplus available to potential third‐party claimants and serves as a rent‐protection device, trading off allocative inefficiency against hold‐up risk. Restrictions on the contracting space can be justified when more realistic features of demand uncertainty or stochastic patent arrival are considered.