Preemptive patenting under uncertainty and asymmetric information

This paper examines the investment behaviour of an incumbent and a potential entrant that are competing for a patent with a stochastic payoff. We incorporate asymmetric information into the model by assuming that the challenger has complete information about the incumbent whereas the latter does not know the precise value of its opponent's investment cost. We find that even a small probability of being preempted gives the informationally-disadvantaged firm an incentive to invest at the breakeven point where it is indifferent between investing and being preempted. By investing inefficiently early to protect its market share, the incumbent gives up not only its option to delay the investment, but also reduces the value of the firm by an amount that increases with the investment cost incurred and the potential loss of market share.