Technology royalty as a strategic impetus in knowledge exchange

Beryl Lihua Kuo
Researcher, Center for Creativity and Innovation Studies, National Chengchi University, Taiwan

Peter J Sher
Professor, Department of International Business Studies, National Chi Nan University, Nantou, Taiwan

Chien-Hsin Lin
Assistant Professor, Department of International Business, Yu Da University, Taiwan

Hsin-Yu Shih
Professor, Department of International Business Studies, National Chi Nan University, Nantou, Taiwan

PP: 59 - 73

Abstract

Joint ventures and technology licensing can involve contracting and royalty-based payments. Payment behavior is not a simple consequence; it may be a strategic impetus to exchange knowledge. Extending the transaction cost economics, this study examines the effects of non-contractible variables on the strategic preference for payment modes. We test hypotheses using information from a survey of 104 Taiwanese firms and partial least square analysis to examine the payment behavior in a technology licensing contract. Considering knowledge tacitness, the licensed technology incurring high transaction costs reduces the source intention to build long-term relationship with the recipient, and thus a fee-based payment is preferred. When shifting the focus of technology or knowledge per se to the heterogeneity of technology recipients, relationship exchange embedded in recipient dependence and learning potential becomes critical in a technology licensing contract, and increase the likelihood of royalty-based payment.

Keywords

royalty payment; knowledge tacitness; recipient dependence; learning potential; knowledge exchange

Article Text

The determinants of technology transfer contracts have been extensively studied (Anand and Khanna 2000; Bessy and Brousseau 1998). Most studies of contracts have been theoretical to analyze the consequences on information asymmetry, moral hazard, and risk aversion, especially in the industrial economics literature (e.g. Bousquet et al. 1998; Gallini and Wright 1990; Macho-Stadler et al. 1996). Although these studies have considerably enhanced our understanding of technology transfer and licensing, they do not directly address payment issues. Negotiating a technology licensing contract benefiting both the source and recipient is not easy, especially for the part of payment modes.

Technology licensing payment occurs within joint ventures, wholly-owned investments, or arm's-length transactions (Reddy and Zhao 1990). Aside from Aulakh et al. (1998), Cebrián (2009) and Vishwasrao (2007), limited studies have empirically analyzed the variables that influence the choice of technology payment modes (c.f. extensive review refers to Cebrián [2009] and Vishwasrao [2007]). According to their findings, the choice of payment modes depends on the source involvement, the quality of intellectual property protection, the prior ties between the transaction parties, and the nature of the technology. These studies focus more on moral hazards and risk sharing but less on the strategic implications of relationship exchange and the effect of varying degrees of recipient in-house technological learning on the choice of payment modes.

The aim of this study is to examine the effects of non-contractible variables on the strategic preference for a royalty-based payment mode in a transfer contract. Extending the transaction cost economics (Williamson 1991), the present study proposes that royalty-based payment behavior in a licensing contract can be understood from the perspective of relationship exchange. Conceptually, transaction parties are not bounded by market mechanism; they are bounded by contracts that specify the obligations and roles of both parties in the relationship. Both parties are bilaterally interdependent because the contracting is a small number phenomenon. Small numbers may cause problem of asset specificity and thus cannot be governed by market mechanism. In contrast to market mechanism, contract relationship is sometimes enduring and may engender social ties in addition to simple economic tie. Payment modes imply the types of ties in a licensing contract.

Moreover, asset specificity, bounded rationality, and opportunistic behavior make transfer contract complicated and thus increase transaction costs (Williamson 1991). Different transaction properties display different transaction costs in a licensing contract, and influence the choice of payment modes. Specifically, knowledge tacitness as a major property of the focal technology influences transaction costs. The characteristic of interdependence, namely sourcing dependence resulted from recipient capacity and recipient dependence resulted from asset specificity, also influences transaction costs. Although opportunistic behavior is expected in a licensing contract and the transaction parties are constrained by bounded rationality, they may still attempt to negotiate an optimal payment mode to reduce opportunistic behavior.

We proposed a simplified continuum of payment modes, which then forms the basis for an empirical analysis of payment mode choice. In the context of foreign technology transfer, this study examines whether knowledge tacitness, recipient dependence, and learning potential enable firms to opt for royalty-based payments when relationship exchange taken into account in contracting. In this vein, we offer several contributions to the technology governance literature. Most of the industrial organization literature examined from the perspective of agency theory suggests that licensing payment mitigates moral hazards (e.g. Agrawal 2006; Macho-Stadler et al. 1996). Initially the technology incurring high transaction costs reduces the source intention to build long-term relationship with the recipient, and thus a fee payment is preferred. However, small numbers and imperfect markets make contracting complicated. Transaction parties would take both relationship exchange and transaction cost into accounts for an optimal payment mode. When shifting the focus of knowledge per se to the heterogeneity of technology recipients, relationship exchange becomes critical in a licensing contract, and transaction parties begins to consider the possibility of royalty-based payment.

The other contribution is we evaluate the impact of technological learning on the payment choice. It shifts our attention away from just being concerned about opportunism, information asymmetry and moral hazard and toward considering that recipient technological learning affects the relationship. The recipient cultivates technological learning that may be regarded as extra offsetting investments to balance its one-sided dependence and in turn enhances the source's incentive to maintain a long-term relationship with the recipient.

In the next section, we first present the definitions and offer hypotheses. After that, we describe our research method and discuss our results. We close by considering the implications and limitations of our study and suggesting opportunities for future research.

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