A Theory of the Royalty Payment and International Technology Transactions.

Abstract

This thesis is a study of technology licensing, wherein an innovator (licensor) licenses a cost-reducing or a new-product technique to an agent (licensee). It has two major objectives. First, it explains why the royalty payment to the licensor by the licensee may be tied to quantity. Second, it investigates efficiency and distributional implications of an ownership restriction on an international joint venture, which may be considered as licensing between the source firm providing technology and the host firm managing the firm. The findings first show that a quantity contingent royalty payment is used as a means of obtaining a Pareto optimal contract when the licensee's production costs are not observable to the licensor while the revenue is observable. Risk sharing is a primary concern that allows us to reach the conclusion in the case of symmetric information. In the case of asymmetric information, the extraction of the largest possible surplus from the informed licensee is the reason for the use of a quantity contingent royalty payment. Furthermore, it is shown that ex post inefficiency may be induced in a quantity contingent contract. With respect to the second objective, the findings show that an ownership restriction forces the source firm to substitute a quantity contingent royalty payment for the share of equity that is restricted. This creates the possibility of deliberately inducing inefficiency in the design of the contract. There is an analogy between an ownership restriction and unobservability in the way inefficiency is induced. As for the distributional aspect, an ownership restriction lowers the expected utility of the source firm while that of the host firm is unchanged.