Licensing process innovations when losersʼ messages determine royalty rates

•An innovator offers unrestricted licenses and royalty licenses to an oligopoly.•Firmsʼ messages signal their own cost reduction to rival firms and to the innovator.•A high threshold level assures existence of an incentive compatible transfer rule.•Adding royalty licenses for losers pointwise lowers winnersʼ transfers.•The royalty income generally exceeds the loss in revenue from the winners.

We consider a licensing mechanism for process innovations that awards a limited number of unrestricted licenses to those firms that report the highest cost reductions, combined with royalty licenses to others. Firmsʼ messages are dual signals of their cost reductions: the message of those who win an unrestricted license signals their cost reduction to rival firms, while losersʼ messages influence the royalty rate set by the innovator. We explain why a sufficiently high threshold level for awarding the unrestricted license is essential to induce truth-telling, show that the innovator generally benefits from the proposed mechanism, and derive conditions for implementability by a modified second-price auction.