A patent is a quid pro quo between the patentee and the public. We view this relationship as an incomplete contract, since a patent can be invalidated in post-issuance litigation in the courts. Building on Grossman and Hart’s (1986) theory of organization, we develop a model of patents as incomplete contracts. We ask whether the joint surplus of the patentee and the public could be increased if control over tasks of the patenting process, normally carried out independently, are accorded to one party. For the case of biotechnology and other high technology inventions, where there exists an information asymmetry between the patentee and the Patent and Trademarks Office (PTO), providing incentives for the patentee to make a more complete disclosure of prior art increases joint surplus. For low technology inventions, the PTO or the courts may not wish to accord such privileges since the benefits of induced R&D may not offset allocative inefficiencies of monopolies.
We consider two specific patent policies. Under Policy 1, prior art disclosed by the patentee to the PTO during patent prosecution is accorded a strong presumption of validity in post-issuance litigation, limiting the use of cited prior art to invalidate the patent. Under Policy 2, there is no presumption of validity accorded to prior art cited by the patentee. These two policies are then considered in the context of low and high technology environments, which are distinguished by the costs of invention and the level of information asymmetry between the patentee and the PTO.
For the case of high technology inventions, Policy 1 induces higher levels of ex ante investment in R&D. The public efficiently trades a strong presumption of validity for information about the prior art. Since prior art is valued by both parties (albeit for different reasons), Policy 1 that encourages its disclosure, could be viewed as a transfer of residual rights that is welfare-enhancing.
For the case of low technology inventions, Policy 2 is optimal, since it allows the public to maintain a low presumption of validity which maintains opportunities for invalidating the patent. We can view these opportunities as bargaining over ex post surplus. In low technology inventions, the increased bargaining has only a small effect on reducing incentives for investment, since R&D projects of this type are undertaken with limited regard to patent protection.