The option value of patent litigation: Theory and evidence

In this paper, I use a real options approach to investigate patent litigation when enforcement is costly, winning is uncertain, and beliefs about validity are stochastic. I consider both finite horizon and infinite horizon models. The theoretical results demonstrate that patent value depends not only upon the underlying technology but also upon the degree of uncertainty over the property right. Additionally, imperfect enforceability creates an effective patent term that is less than the statutory term. Using simulation methods and patent data, I estimate the hazard rate of patent litigation. Contrary to previous studies, I find that the rate of forward citations is negatively associated with the litigation rate. The difference arises because (1) I use a dynamic model that exploits the information contained in the timing of litigation and citations, and (2) I control for truncation using a duration model. Using random effects models, I find that heterogeneity in patent litigation is embedded primarily in the heterogeneity in receiving patent citations. Because of this, the patent litigation decision can be modeled as a unilateral decision.