Patent licensing to Bertrand competitors

A cost-reducing process innovation protected by a patent is sold to one of several firms engaged in price competition. Incomplete information about production costs yields an auction model with both private and common value components. Our main result is that standard auction mechanisms lead to inefficient allocations. This sharply contrasts with the result obtained under complete information. The inefficiency result extends to patent race frameworks which resemble all-pay auctions. An auction where the lowest bidder gets the patent is shown to have several equilibria, one of which is efficient.