The Role of Equity, Royalty, and Fixed Fees in Technology Licensing to University Spin-Offs

Savva, N and Taneri, N (2015) The Role of Equity, Royalty, and Fixed Fees in Technology Licensing to University Spin-Offs. Management Science, 61 (6). pp. 1323-1343. ISSN 0025-1909

Abstract

We develop a model based on asymmetric information (adverse selection) that provides a rational explanation for the persistent use of royalties alongside equity in university technology transfer. The model shows how royalties, through their value-destroying distortions, can act as a screening tool that allows a less-informed principal, such as the university's Technology Transfer Office (TTO), to elicit private information from the more informed spin-off. We also show that equity-royalty contracts outperform fixed-fee-royalty contracts because they cause fewer value-destroying distortions. Furthermore, we show that our main result is robust to problems of moral hazard. Beside the coexistence result, the model also offers explanations for the empirical findings that equity generates higher returns than royalty and that TTOs willing to take equity in lieu of fixed fees are more successful in creating spin-offs.