Agency Theory of Patent Law:

1. Agency Theory of Patent Law: Linking Innovators and Invention Users Richard Gruner Professor of Law Whittier Law School 7th Annual CIPLIT® Symposium2007 DePaul University College of Law

2. Main Themes • Enhanced Rewards Theory: Patent Rewards to Economize on the Time of Talented Individuals • The Basic Agency Model: Patent-Mediated Agency Relationships • The Extended Agency Model: Employers and Employees as Allocated Risk Takers in Innovative Enterprises

3. Towards an Improved Reward Theory • Most Patentable Advances are Produced by Parties with Exceptional Knowledge or Skills • Domain-Specific Knowledge About Practical Problems • Technology-Specific Knowledge About Capabilities of Engineering Design Approaches • Same Special Knowledge and Skills Are Often Valuable in Other Tasks • Diverse Other Engineering Efforts • Academic Research • Business Management

4. Towards an Improved Reward Theory (Cont.) • Patent Rewards Must Trump Second Largest Rewards Available to Talented Parties • Mere “Reasonable Return” Over Costs of Innovation Will Not Be Enough • Rewards Up to Full Social Benefit of Innovation Will be Socially Advantageous • Even These Rewards will Not Ensure that All Cost-Effective Innovations are Encouraged • Other Rewards Presented to Talented Parties May Still Trump Innovation Rewards and Preclude Innovation

5. Towards an Improved Reward Theory (Cont.) • Patent Rewards Scaled to Social Benefit of an Innovation Will Aid in Economizing Time Allocations of Talented Parties • Work on Patentable Advance is “Priced” at Social Benefit Amount • Prioritizes this Effort Relative to Social Gain • Rewards Should Attract the Attention of Talented Innovator Except Where Another Party or Reward Scheme Makes a Higher “Bid” • Improves Allocation of Scarce Resource Involved in Talented Individual’s Efforts

6. Agency Theory of Patent Law • The Basic Model: Patent-Mediated Agency Relationships • Key Features of Agency Theory • Agency Implications of Patent Incentives • Boundaries of Patentable Subject Matter from an Agency Perspective • Agency Impacts of Other Patent Features

7. The Basic Model: Patent Rights as Contractual Substitutes • Innovators Generally Seek to Advance Interests of Invention Users • Innovation Efforts Undertaken as Agents of Potential Users • Contract Efforts Suffice to Link Innovators and Users in Small Scale Environments • Patents Serve as Contract Substitutes in Settings Where Contracts Fail

8. The Basic Model: Essential Agency Relationship Features • Actions of One Person on Behalf of Another • Incentives Presented to Actor Encouraging Furtherance of Second Party’s Interests • Information Gathering and Analysis to Determine if Rewards Should be Paid to Agent • Criteria for Rewards May be Agent’s Efforts or Results Achieved

9. The Basic Model: Contractual Agency Relationships • Contract Between Principal and Agent Dictates Scope of Agent’s Rewards and When They Are Due • Examples of Contractual Agency Relationships • Homeowner Promises to Pay Individual to Mow Lawn • Client Engages Lawyer to Provide Legal Services • Patient Seeks Medical Assistance from a Doctor

10. The Basic Model: Agency Relationships Without Contracts • External Framework Dictates Nature of Agent’s Rewards and When They are Due • Examples of Non-Contractual Agency Relationships • Prevention of Harmful Pollution Under Threat of Criminal Fines • Care to Prevent Accidents Harming Others Under Threat of Negligence Liability • Innovation for the Benefit of Invention Users Under the Encouragement of Patent Rights and Rewards

11. The Basic Model: Distinguishing Agency Law • Agency Law Addresses Relationships Formed By Contract • Authority of Agents to Bind Principals to Obligations or Liability • Default Terms Regarding Relationships Between Principals and Agents • Protections Afforded to Third Parties When Principals Choose to Act Through Agents

12. The Basic Model: Distinguishing Agency Law (Cont.) • Agency Behavior Does Not Depend on Agency Law • Agency Present When One Party Pursues Interests of Another • Concern is How to Influence Agents to Pursue Principal’s Interests Effectively and Efficiently • Further Issues Regarding How to Monitor Agents’ Actions and Provide Rewards in Appropriate Circumstances

13. Key Features of Agency Theory • Focuses on Means to Create Optimal Principal-Agent Relationships • Optimal Relationships Encourage Agents to Pursue All Actions that Are Cost-Effective for Principals • Transaction Costs May Limit Otherwise Optimal Solutions

14. Key Features of Agency Theory(Cont.) • Typical Problems Addressed • Sources of Goal Incongruence Between Principals and Agents • Means to Efficiently Organize Information Gathering and Transfers in Principal-Agent Relationships • Optimal Allocations of Risks in Principal-Agent Relationships • Means to Adjust Risks Between Principals and Agents

15. Agency Theory Implications for Patent Incentives • Identifies Factors Influencing Agents’ Incentives: • Innovation Outcomes And Perceived Values • Probability of Outcomes • Linkages Between Efforts and Outcomes • Principals’ Observations of Agents’ Efforts • Fees Paid to Agents Based on Efforts or Outcomes or Both • Agents’ Utility Functions

16. Agency Theory Implications for Patent Incentives (Cont.) • Patent-Mediated Rewards Will Be Optimal If: • The Expected Aggregate Utility to Invention Users is Maximized Over Alternative Reward Schemes • An Innovator Achieves Her Maximum Reward Via Effort Promoting the Maximum User Utility; and • The Innovator’s Reward is at Least As Large as Rewards Available Through Alternative Activity

17. Boundaries of Patentable Subject Matter: An Agency Interpretation • Patentable Subject Matter Determines When Patent Rewards Encourage Innovation • Patent Rewards Needed Where Contracting to Encourage Innovating Agents is Likely to Fail • Circumstances of Likely Contract Failure Include: • Large Groups That Are Foreseeable Targets of Innovation, But are Unlikely to Establish Effective Contracting Groups; or • Narrow Sets of Innovators Who May be Difficult to Locate to Establish Contracts

18. An Expanded Agency Model: Innovation by Employees • Corporate Innovation by Employees is Accomplished by a Combination of Agent (Corporation) and Subagent (Employee) • Goals of Corporation are Similar to Those of Agent in Basic Model • Incentives Measured by Social Gain and Patent Rewards • Corporate Payoffs from Patents Obtained Via Assignments • Goals of Employees Must be Secured Via Additional Agency Processes • Establishing Incentives to Pursue Corporation’s Patent Interests • Providing Payoffs for Successful Results

19. An Expanded Agency Model: Innovation by Employees (Cont.) • Multi-Agent Model Illuminates Innovation Risks Accepted by Corporations And Employees • Corporations Can Bear Large Innovation Risks on a Risk-Neutral Basis • Ability to Raise Large Capital Amounts • Ability to Organize Applications of Large Amounts to Innovation • Competing Pressures for Internal Capital Allocations Ensure Risk-Neutral Allocations to Potential Innovation

20. An Expanded Agency Model: Innovation by Employees (Cont.) • Employees Can Pursue Innovation With Varying Degrees of Risk-Aversion • Work on Innovation for Salary is Risk-Averse Choice • Small Salary/Large Potential Bonus Combination Entails Higher Risk Taking By Employee • Mix of Salary Size and Bonus for Innovation Can be Adjusted to Fit Risk Preferences of Particular Employees With Key Skills or Knowledge

21. Conclusion: Advantages of Agency Theory for Patent Analyses • Focuses on Patent System Goal of Enhanced Utility for Invention Users • Views Patent Features As Means to Encourage Efficient Enhancement Of Invention Users’ Utility • Emphasizes Influence of Patent Rights on Innovation Process, Not Asset Control

22. Conclusion: Advantages of Agency Theory for Patent Analyses (Cont.) • Provides Established Framework for Considering the Implications of Incentives, Information, and Risk Sharing in Innovation Relationships • Defines Desirable Scope of Contractual and Patent Inducements for Innovation • Suggests Strategies that Corporations and Universities May Use to Encourage Optimal Innovation Efforts