REAL OPTIONS AND PATENT DAMAGES: THE LEGAL TREATMENT OF NON-INFRINGING ALTERNATIVES, AND INCENTIVES TO INNOVATE

Abstract.  Patent litigation has become an increasingly important consideration in business strategy. Damage awards in patent litigation are supposed to compensate the patent owner for economic harm created by infringement and are therefore important for protecting returns to innovation. We analyze the effects that a recent court decision in the United States, called Grain Processing , has had on the incentives of potential infringers to infringe and innovators to innovate. We find that Grain Processing has decreased the expected value of damages awards in patent cases by conferring a 'free option' on infringers. Grain Processing also concluded that the patent owner in the case did not suffer lost profits due to the infringement because the infringer would have adopted an (inferior) non-infringing technology had it not infringed. We demonstrate that this conclusion is inconsistent with standard economic models.