Incumbency and R&D Incentives: Licensing the Gale of Creative Destruction

This paper analyzes the relationship between incumbency and innovative activity in the context of a model of technological competition in which technologically successful entrants are able to license their innovation to (or be acquired by) an incumbent. That such a sale ought to take place is natural since the post-innovation monopoly profits are greater than the sum of duopoly profits. The model integrates insights about the economic determinants of licensing fees (such as the size of knowledge spillovers or the sunk costs of product market entry) into the canonical model of technological competition under uncertainty. In so doing, we identify three key findings about how bargaining power during licensing negotiations impacts the incentives to engage in R&D. First, since an incumbent