James J. Anton and Dennis A. Yao
Jounal of Economics and Management Strategy 12(2) 151-178 Summer 2003
Abstract: The patent system encourages innovation and knowledge disclosure by providing exclusivity to inventors. Exclusivity is limited, however, because a substantial fraction of patents have some probability of being ruled invalid when challenged in court. The possibility of invalidity--and an ensuing market competition--suggests that when an innovator's capability (e.g. cost of production) is private information, there is potential value to an innovator from signaling strong capability via a disclosure that transfers technical knowledge to a competitor. We model a product innovation setting in which a valid patent gives market exclusivity and find a unique signaling equilibrium. One might expect that as the probability that a patent will be invalid becomes quite low, greater disclosure would be induced. We do not find this expectation to be generally supported. Further, even where full disclosure arises in equilibrium, it is only the less capable who make full disclosures. The equilibrium analysis also highlights many of the novel and appealing features of enabling knowledge disclosure signals.