Chapter 2: THE NEXUS BETWEEN THE ILLIQUIDITY OF THE PATENT
2.3 Part II: Bargaining and Negotiation Costs
2.3.2 The Microscopic Level
Having discussed the macroscopic aspect of bargaining and negotiation costs, focus now turns to the microscopic aspect. This aspect is occasioned by behavioural and social conditions such as bounded rationality, informational asymmetries and strategic behaviour, irrational considerations and the difficulties of finding parties to transact with.
Bounded rationality relates to the cognitive and decisional limitations of humankind, 155 particularly our limited capacities to collect all necessary
information, process it effectively and make quality decisions.156 The effects of
bounded rationality are best perceived in agreements on the price to be paid in the acquisition or licensing of patents. Clarkson explains that there are several customary approaches to determining the price of IP assets but that these assessments are based on parameters which are largely uncertain, nebulous and disputed by parties due to bounded rationality on one or both sides.157 Therefore,
in most cases, parties end up with ‘satisficing’ or heuristic prices, which is apt to cause patents to be overvalued or undervalued.158
Merges explains that, where there is a divergence in the valuation of patents, the prospects of transactions occurring will be low.159 This is likely to culminate in the
protraction, if not frustration, of agreements.160 Bounded rationality, Merges also
posits, has led to major historical breakdowns in bargaining. He cites the examples
155 Daniel Kahneman, ‘Maps of Bounded Rationality: Psychology of Behavioral Economics’ (2003)
93 The American Economic Review 1449-1475.
156 Russell Korobkin and Thomas Ulen, ‘Law and Behavioral Science: Removing the Rationality
Assumption from Law and Economics’ (2000) 88 California Law Review 1053-1143.
157 Ibid. 158 Ibid.
159 Robert Merges, ‘Intellectual Property Rights and Bargain Breakdown: The Case of Blocking
Patents’ (1994-1995) 62 Tennessee Law Review 78-79 (‘In standard economic theory, strategic bargaining will sometimes cause a bargain to fail despite the availability of cooperative surplus.’).
of the Marconi and De Forest companies, which failed to work in collaboration with each other over their respective patents, leading to stagnation in the advancement of radio technology until government intervened.161 He also cites
the example of the historic Bessemer and Mushet blocking patents, which retarded the advancement of steelmaking technologies in the USA.162 These
incidents, he opines, could have been avoided had the different patent owners agreed to work together. In short, bounded rationality is apt to upset the smooth functioning of the patent market by causing both sides of the bargain, the patentees and users, to lose sight of the likely cooperative surplus that can accrue to them through bargaining.
Asymmetric information and strategic bargaining relates toa situation in which there is a cleavage or imbalance in the quality of information possessed by parties in a given situation. Akerlof theorizes that if a party to a proposed transaction possesses more information than other parties, the party with the informational advantage is most likely to capitalize upon that edge to his own benefit.163 This, in
most cases, would be detrimental to the interests of the other party.
Other scholars have supported the proposition that where there is information asymmetry, the party with the information edge is likely to act strategically to his favour and get the best deal for him or herself.164 This is certainly plausible. It has
been argued, with respect to patents, that the patentee is likely to possess better information about the value and technological merits of his or her patents. It follows that ‘(t)he licensee as the less-informed party has to be educated as to the value of the innovation…..’165 Others, however, argue that intending users are
more likely to possess better information about the value and technological merits of inventions, rather than the inventors. Reepmeyer et al. studied licensing in the
161 Ibid. 162 Ibid.
163 George Akerlof, ‘The Market for “Lemons”: Quality Uncertainty and the Market Mechanism’
(1970) 84 The Quarterly Journal of Economics 488-500.
164 Ines Macho-Stadler, ‘The Role of Information in Licensing Contract Design’ (1996) 25 Research
Policy 43-57; see also Charles Hill, ‘Strategies for Exploiting Technological Innovations: When and When Not to License’ (1992) 3 Organization Science 428-441.
pharmaceutical industry.166 They assert that licensees are more likely to possess
better competence in developing inventions, dealing with regulatory bodies, carrying out clinical testing in a timely manner, producing market quantities and improving marketing networks.167 Consequently, they are in a better position to
assess the value of patents.
The upshot of information asymmetry in the patent market, as regards transaction costs and illiquidity, is that both patentees and users of technology might hold out. In either case holding out could interminably delay or frustrate the conclusion of a bargaining process. This could have the effect of depriving not just both parties the dividends of cooperative surplus, but also dampening social welfare.
Irrational considerations,asMerges asserts, being factors that are not founded on bounded rationality but on sheer irrationality, could also stifle bargaining. As Merges notes: ‘This is not to suggest that a party pursuing this course must be mentally ill or deficient; instead, it is meant to be a catch-all phrase to include motives such as spite, pride and anger’.168 There are various examples of irrational
considerations: patentees may have unrealistic expectations of the value of their patents; third parties may choose deliberately not to license-in patents, even when they are aware of their existence;169 patentees may, for reasons of pride or
commercial vendetta, refuse to license.170 The obvious implication of irrational
considerations is a retardation of the smooth conclusion of patent transactions. Difficulties in finding willing parties can be another crippling problem at the microscopic level. Agrawal et al. argue that ‘market thickness’, which relates to the ‘opportunities to trade with a wide range of potential transactors’, is one of the
166 Gerrit Reepmeyer, Oliver Gassmann and Frauke Rüther, ‘Out-licensing in Markets with
Asymmetric Information: The Case of Pharmaceutical Industry’ (2011) 15 International Journal of Innovation Management 755-795.
167 Ibid.
168 Robert Merges, ‘Intellectual Property Rights and Bargain Breakdown: The Case of Blocking
Patents’, n153, 78-91.
169 See Matthew Powers and Steven Calson, ‘The Evolution and Impact of the Doctrine of Willful
Patent Infringement’ (2001) 51 Syracuse Law Review 53-112.
170 Joseph Yosick, ‘Compulsory Patent Licensing for Efficient Use of Inventions’ (2001) 2001
biggest problems confronting the market for ideas, particularly patents.171 Based
on a survey of firms licensing out patents in Europe and Japan, Zuniga and Guellec conclude that an inability to find parties intending to license had hampered the development of a patent market or the effective licensing of patents.172 Gans and
Stern argue that the presence of market intermediaries or private market mechanisms that can help bridge the gap between patent owners, and willing buyers and licensees could help improve the market thickness deficit.173 In the
USA, there appears to be a fast-growing and somewhat settled practice of technology transactions being facilitated by patent brokerage services, where firms such as Ocean Tomo, and Intellectual Ventures aggregate patents and offer them for sale/auctions and licensing. 174 This has been emulated in other
jurisdictions, including as the UK175 and Australia.176 However, information costs
appear to be the predominant factor responsible for this phenomenon, even with the growing presence of market intermediaries. 177
In sum, these microscopic factors can bring about a frustration of the patent market, either alone or in combination with one another. Where they do arise, asset specificity might be difficult to overcome and as such the potential for opportunism becomes increasingly possible.
171 Ajay Agrawal, Iain Cockburn and Laurina Zhang, ‘Deals Not Done: Sources of Failure in the
Market for Ideas’ (2013) NBER Working Paper No. 19679, available at
http://www.nber.org/papers/w19679 (last acceessed 02/08/2016).
172 Maria Zuniga and Dominique Guellec, ‘Who Licenses Out Patents and Why? Lessons From A
Business Survey’(2009) STI Working Paper 2009/5 Statistical Analysis of Science. Technology and Industry Organisation for Economic Co-operation and Development.
http://www.oecd.org/science/inno/42477187.pdf (last assessed 0n 02/04/2014)
173 Joshua Gans and Scott Stern, ‘Is There a Market for Ideas? (2010) 19 Industrial and Corporate
Change 805-837.
174 Colleen Chien, ‘From Arms Race to Marketplace: The Complex Patent Ecosystem and Its
Implications for the Patent System’ (2010) 62 Hastings Law Journal 299-355.
175Mario Benassi and Alberto Di Minin ‘Playing in Between: Patent Brokers in Markets for
Technology’ (2009) 39 R&D Management 68-86.
176 Paul H. Jensen, Alfons Palangkaraya and Elizabeth Webster, ‘Trust, Incomplete Contracts and
the Market for Technology ‘ (2013) Intellectual Property Research Institute of Australia, Working Paper No. 2/13, available at http://www.ipria.org/publications/wp/2013/WP213.pdf (last accessed on 02/04/2014).
177 See, Allen Wang, ‘Rise of the Patent Intermediaries’ (2010) Berkeley Technology Law Journal
2.3.3 The Implications of Bargaining and Negotiation Costs for the