A Theory of Pre-Litigation Settlement and Patent Assertion Entities

Abstract

An informed (prospective) plaintiff can send a take-it-or-leave-it demand to an uninformed (prospective) defendant with the threat of a lawsuit that may not be credible. In this context, the well-known perfect sepa- rating equilibrium in litigation bargaining game (Reinganum and Wilde, 1986) no longer exists, and all perfect Bayesian equilibria with pre-filing settlements exhibit a cutoff feature. These equilibria offer an explanation for the distinctive behaviors of Litigation PAEs, who aggressively file lawsuits for settlements, and Portfolio PAEs, who obtain licensing revenues through pre-filing settlements. Our comparative statics results lead to testable hypotheses regarding how litigation costs and the plaintiff’s reputation affect the settlement amount before and after the cases are filed, and the frequency of lawsuits from a given plaintiff.