ESTIMATING THE GAINS FROM TRADE IN THE MARKET FOR PATENT RIGHTS

• Author: Carlos J. Serrano
• Date: 01 November 2018
• Published date: 01 November 2018
• DOI: http://doi.org/10.1111/iere.12338

INTERNATIONAL ECONOMIC REVIEW

Vol. 59, No. 4, November 2018 DOI: 10.1111/iere.12338

ESTIMATING THE GAINS FROM TRADE IN THE MARKET FOR PATENT RIGHTS∗

BYCARLOS J. SERRANO1

Universitat Pompeu Fabra and Barcelona GSE, Spain

The “market for patents”—the sale of patents—is an often discussed source of incentives to invest in R&D.

This article presents and estimates a model of the transfer and renewal of patents that, under some assumptions,

allows me to quantify the gains resulting from the transfer of patents. The gains from trade measure the private

benefits of reallocating the ownership of a patent from the original patentee to a new owner for whom the patent

has a higher value. In addition, I study the effect that lowering transaction costs has on the proportion of patents

traded and the gains from trade.

1. INTRODUCTION

The market for patent rights—the sale of patents—is an often discussed source of incentives

to invest in R&D, especially for small firms for which patents are typically their critical assets.

This market can generate gains from technological trade by facilitating the reallocation of

innovation to firms that are more effective at commercializing the patented innovations (Arora

et al., 2001a; Serrano, 2006, 2010) or at resolving disputes over these rights without resorting

to the courts (Galasso et al., 2013). Despite these private and social benefits, transactions in

patent rights may also generate social costs. This can occur if patent rights get reallocated to

entities that have the capacity and the incentives to exploit the patents to extract excessive

royalty fees by holding up rivals and/or infringers (see, e.g., Shapiro, 2001; Lemley and Shapiro,

2005). The key to understanding the overall impact of transactions in patent rights is to assess

quantitatively the different ways in which the market for patents affects social welfare.2

This article takes a first look at quantifying the private gains from patent sales in the market

for patents. The gains from trade measure the private benefits from the actual reallocation of

the ownership of a patent from the original patentee to a new owner for whom the patent has

a higher value. This is a first step toward understanding the broader policy issue of whether

patent transactions increase total welfare. If these private gains from trade were significant,

they could potentially offset concerns about hold-up problems and patent “trolling.” I develop

and estimate a model of patent sales and renewals that, under some assumptions, allows me

to recover the gains resulting from the sale of patents. My method allows me to quantify the

distribution of patent values and the distribution of gains from trade from selling one patent

∗Manuscript received February 2013; revised July 2017.

1I would like to thank the editor and three referees for comments and suggestions that helped improve the article.

I also thank Thomas Holmes, Sam Kortum, Victor Aguirregabiria, Zvi Eckstein, Nicolas Figueroa, Suqin Ge, Flor

Gragera de Leon, Hugo Hopenhayn, Chris Laincz, Katherine Lande, Rob McMillan, Matt Mitchell, Valeriu Omer,

Ariel Pakes, Andy Skrzypacz, and seminars participants for feedback and suggestions. I gladly acknowledge Ryan

Lampe’s generosity for providing access to the raw data of Ocean Tomo patent auctions. All errors are mine. Please

address correspondence to: Carlos J. Serrano, Department of Economics and Business, Universitat Pompeu Fabra,

Ramon Trias Fargas, 25-27; 08005 Barcelona, Spain. Phone: +34-93-542-1532. E-mail: carlos.serrano@upf.edu.

2The issue is at the center of recent reports by the U.S. Federal Trade Commission (FTC, 2011, 2012) analyzing

the working of the market for patent rights. See the report on the “The Evolving IP Marketplace: Aligning Patent

Notice and Remedies with Competition” by the Federal Trade Commission (March 2011) and more recently, the

“Patent Assertion Entity Activities Workshop” jointly sponsored by the Department of Justice and the Federal Trade

Commission (December 2012; http://www.ftc.gov/opp/workshops/pae/).

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(2018) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social

and Economic Research Association

1878 SERRANO

from one firm to another one. In addition, I estimate market transaction costs and study the

effect of lowering transaction costs on the patent market.

I make use of patent assignment data to identify changes in the ownership of patent rights. An

interesting feature of the sale of patents—that distinguishes it from the licensing of patents—

is the fact that the sale of patents is most often publicly recorded because of the legal re-

quirement that all patent sales have to be filed with the United States Patent and Trade-

mark Office (USPTO) to be legally binding (Dykeman and Kopko, 2004). This property

of patent sales allows me to link these transactions to patent numbers, which can then be

merged to the basic patent data that others have used: the payment of renewal fees, patent

citations, the patent’s issue date, a patentee identifier, etc. (Pakes and Schankerman, 1984;

Griliches, 1992; Hall et al., 2001). A challenge in using patent assignment data is to distin-

guish changes in patent ownership from other events. To do this, I follow Serrano (2010) and

conservatively drop all the assignments that appear not to be associated with an actual patent

trade.3

In my empirical analysis, I focus on patents applied for and granted to small firms. I op-

erationalize this focus by restricting attention to patents granted to firms with no more than

500 employees as of the application date of the patent. There are a number of reasons that

support my attention on these patents. The first one is that in the policy arena there exists

special interest in the importance that the market for patents plays on the incentives to in-

vest in R&D by small firms (FTC, 2011). Another reason is that by focusing on small firms

the economic forces that I highlight will be more salient than in transactions involving the

patents from larger firms or other patentees.4At the same time, the focus on small firms

allows me to parallel my empirical analysis with the existing theory on patent renewals, in

which the decision making is at the patent level. Furthermore, small firms are interesting in

their own right, given the importance they play in the innovation process (Arrow, 1983; Acs and

Audretsch, 1988).

I then develop a theory of patent sales and renewals. The starting point of my model is

Pakes (1986) and Schankerman and Pakes (1986). They examine the problem of a patent owner

deciding in each time period whether or not to pay a renewal fee, and thereby to extend the

life of a patent, in a context of heterogeneity in the economic value of inventions. The distinct

element of my model, which differentiates it from Pakes and Schankerman, is the introduction

of the possibility of the arrival of opportunities for surplus-enhancing transfers, which may lead

to a transfer of patent to a new owner for whom the patent has a higher value. However, to

transfer the patent to a new owner involves a transaction cost. The gains from trade measure

the net benefits of reallocating the ownership of a patent from the original patentee to a new

owner. The intuition of the model is simple. First, transaction costs create a selection effect, so

that patents with higher per period returns are more likely to be traded. This selection effect can

account for the observed pattern that previously traded patents are more likely to be retraded

and less likely to expire than the previously untraded patents. Second, there is a horizon effect

that explains why the probability is that an active patent decreases as patents get closer to their

expiration date. A shorter horizon implies less time to amortize the market transaction costs. In

summary, whereas Pakes and Schankerman’s framework has one margin—whether the patent

owner should pay the fee for renewing the patent—my model has a second margin—whether a

transaction cost should be covered to reallocate the patent to an alternative owner.

The parameters of the model are estimated using the simulated generalized method of mo-

ments (McFadden, 1989; Pakes and Pollard, 1989). The empirical moments I use to identify

these parameters describe both the patent life cycle properties of the trading and expiring

3Serrano (2010) documents the dynamics of the sale and renewal of patents. He studies the effect of firm size, patent

age, patent citations, patent generality, patent technology classes, whether a patent was previously traded, etc. on the

decision to trade and renew a patent.

4Serrano (2010) reports that patents granted to large corporations may be traded not only for the technology that

they represent, but also as a result of large acquisitions that may be pursued to increase the buyer’s market share in a

particular product market, etc.