Ad Valorem Versus Per‐unit Royalty Licensing in a Cournot Duopoly Model

Abstract

Ad valorem royalty licensing is implemented when the licensor (i.e., patent‐holding firm) obtains ownership shares in the licensee as payment once the new technology is transferred. In a Cournot duopoly model, we compare two licensing forms between competitors of different productivity, ad valorem and per‐unit royalty licensing. This paper finds that ad valorem royalty licensing is superior to per‐unit royalty licensing for the patent‐holding firm when the cost‐reducing innovation is non‐drastic. The reason for this result is that cross ownership reduces output market competition and thus the patent‐holding firm enjoys better profit margins by strategically setting the share ratio. Furthermore, we show that the relieved competition under ad valorem royalty licensing pulls down the industry output, and thus hurts consumer surplus and social welfare in comparison to per‐unit royalty licensing.