Attracting Skeptical Buyers: Negotiating for Intellectual Property Rights

James J. Anton (Duke) and Dennis A. Yao (Harvard)

International Economic Review, Vol. 49, No. 1, pp. 319-348, February 2008

How do confidentiality agreements function in the sale of intellectual property?

Purpose and setting

• Idea Disclosure and Expropriation - Many buyers are skittish about getting involved in negotiations with sellers of intellectual property (IP), especially when the property is not protected by patent or copyright. This is a major concern for venture capitalists when dealing with start-up firms. A reason for this behavior is that buyers lack information about the value offered by the seller. Yet, sellers are reluctant to disclose the required value-establishing knowledge because of legitimate fears that the knowledge will be expropriated. Given these concerns, how are knowledge-based transactions facilitated?
• Confidentiality Agreements - Disclosures can, of course, be protected in principle through a confidentiality contract which gives the seller the right to sue for unauthorized use of the disclosed information and is negotiated prior to substantive knowledge exchanges. Yet we frequently observe in practice that sellers waive their rights to confidentiality.

Results

• Strategic Waiver - In this paper we provide an incomplete information explanation for why a seller will sometimes waive confidentiality even when confidentiality would have been maintained under complete information. To the seller, the decision to waive rights involves giving up the value associated with a confidentiality right in exchange for an increase in buyer participation.
• Attracting Buyers - Our analysis incorporates the endogenous interaction of three critical elements—the underlying sources of buyer skepticism—which affect buyer participation: uncertainty about the value of the IP being offered, value dissipating effects when buyers must compete for the seller's IP, and costs associated with ex post lawsuits claiming expropriation.

Conclusion -- Waiving confidentiality rights can encourage buyers to participate more actively

• Strategy – The strategic option to ‘waive' a confidentiality agreement and signal via disclosure needs to be evaluated whenever buyer participation in the sale process is a concern (even for sellers with a valuable idea).
• IP Policy – In contrast to contracted rights such as confidentiality rights, in the context of a sale transaction, patents and copyrights benefit sellers because they operate like “universal contracts” that force buyer participation. Thus, even when a patent is quite weak (i.e., low expected damages), obtaining a patent may still improve the ability of the seller to increase payoffs because the patent makes the property right damage unavoidable and thereby leads to increased participation by the buyers.
• Empirical Implications – Our results lead to predictions about the use of waivers and the extent of disclosure. We identify, for example, when the correlation between the seller's market power and waivers will be weak or absent. A second set of implications concerns the link between measures of IPR expected damages and disclosure. For example, when expropriation is a concern, we find the counterintuitive prediction that disclosure (or possible proxies) will fall as the IPR damage rises.