Licensing Non- and (Super-)Drastic Innovations: The Case of the Inside Patent Holder∗

The present paper reconsiders licensing by an inside innovator under incomplete informa-tion. Contrary to what was claimed in the literature, the optimal mechanism for non-drastic innovations prescribes royalty rates lower than the cost reduction and generally exhibits fixed fees and exclusion; for drastic innovations fixed-fee contracts are optimal under complete in-formation, whereas under incomplete innovation, output based royalties are profitable because linking the license fee to a variable that is correlated with the licensee’s private information tends to lower information rents