Patent-investment games under asymmetric information

This paper analyzes preemptive patenting in a two-stage real options game where an incumbent firm competes with a potential entrant firm for the patent of a substitute product in a product market with profit flow uncertainty. The incumbent suffers loss of monopoly in the product market if the entrant acquires the patent of a substitute product and later commercializes the product. Our patent-investment game model assumes that the entrant has complete information on the incumbent’s commercialization cost while the incumbent only knows the distribution of the entrant’s cost. We investigate the impact of information asymmetry on the preemption strategies adopted by the two competing firms on patenting the substitute product by comparing the optimal preemption strategies and the real option value functions of the two competing firms under complete information and information asymmetry. Our analysis reveals that the informationally disadvantaged incumbent always suffers from loss in its real option value of investment since it tends to act more aggressively in competing for the patent. On the other hand, the real option value of investment of the informationally advantaged entrant may be undermined or enhanced. The incumbent’s aggressive response under information asymmetry may lead to reversal of winner in the patent race. We also examine how information asymmetry may affect the occurrence of sleeping patent and the corresponding expected duration between the two stages of patenting and product commercialization.

► The perfect Bayesian equilibrium approach is used to analyze preemption strategies.
► The information disadvantaged firm always suffers loss in its real option.
► Real option value of the information advantaged firm may be undermined or enhanced.
► Aggressive response under information asymmetry may lead to reversal of winner in race.
► Sleeping patent and expected duration between two stages of investment are examined.