Brian Chau is a JD Candidate at Osgoode Hall Law School.
In a recent article, Christopher J. Buccafusco and Christopher Jon Sprigman consider whether IP transactions are subject to “endowment effects”. The endowment effect is a human behavioural phenomenon in which an individual’s perceived value of an object they own is greater than the value prescribed by an objective third party.
This bias was demonstrated in experiments held in 1990 by Kahneman, Knetsch and Thaler, who found that randomly assigned owners of a mug required significantly more money to part with their possession than randomly assigned buyers were willing to pay to acquire it. The endowment effect is important because it sheds light on a hidden transaction cost that exists in the market: the valuation asymmetry between buyers and sellers has a significantly detrimental effect on overall market efficiency, especially in markets where participants have few guideposts to rely upon.
IP is very different than the traditional cases of the endowment effect – as an intangible creation of statute, it exists without physical substance, and there is a general lack of well-defined methods for determining value. Given IP’s growing role in many of the world’s largest and most powerful companies, an understanding of the endowment effect is necessary in helping to guide the evolution of IP rights, laws and licensing.
The study reports on an experiment considering a possible valuation asymmetry between authors of poems and potential purchasers of them, in the context of an IP licensing system. The study focuses on property that was both created by the owners, and non rival (consumption by one person does not prevent the consumption by another). In particular, an analysis was conducted on the prices that buyers were willing to pay (WTP) and sellers were willing to accept (WTA).
The results of the study indicated that there exists a statistically significant difference between the WTP and WTA, suggesting that high transaction costs exist due to cognitive biases. These transaction costs in turn lead to suboptimal levels of market activity, as a gap exists where potential buyers and potential sellers are unable to arrive at a price that satisfies both parties.
The authors tested their hypotheses using a set of experiments with three parties participating: Authors, Owners and Bidders. The demographic consisted of a group of 287 paid participants with a mean age of 24.
(1) The Contest “Eyes Closed” Method – Authors were invited to the lab to write haikus in a competition, where they were told that following a selection process (the writer of the best poem would receive $50), ten potential bidders would be given the opportunity to buy the chance of winning the the $50 prize. The Author indicated a price they were willing to accept (WTA) for their poem.
Next, Bidders were brought to the lab where they were told that they could buy the rights of the poem to the contest for a price, if the bid they entered (WTP) was greater than the Author’s WTA for that particular poem.
Finally, Owners were brought to the lab where they were assigned a poem written by an Author. For each of these poems, the Owners were told that they owned the rights to the prize money ($50), provided that their poem won the competition. They were placed in similar shoes as the Authors – they indicated the price they were willing to accept (WTA) for the rights to the potential winnings.
In all these cases the Authors, Bidders and Owners were provided additional follow-up questions to understand their motivations.
(2) The Contest “Eyes Open” Method – A variation of the contest where the Authors, Bidders and Owners were all shown the ten poems in the competition, including their own. The intention of the experimenters was to understand whether additional information would change the outcome of the contest.
(3) The Contest “Blind” Method- A variation of the contest where the Authors, Bidders and Owners were told that the poems would be selected at random for the prize.
WTA difference between Owners and Authors not significant – The average WTA of the Owners and Authors was $21.23 and $22.90 respectively – not a statistically significant difference.
The WTA-WTP difference between Bidders and Owners/Authors was significant – On the other hand, the Bidders average WTP was $10.38, lending itself to quite a large gap (more than 2-1).
WTA difference between Owners and Authors not significant – The average WTA of the Owners and Authors was $23.45 and $20.05 respectively – again, not a statistically significant difference.
The WTA-WTP difference between Bidders and Owners/Authors was significant – On the other hand, the Bidders average WTP was $9.21, lending itself to quite a large gap (again, more than 2-1).
The WTA-WTP difference between Bidders and Owners/Authors was significant – Authors assigned a value of $18.92, Owners $15.98, and Buyers $5.60.
Between Contest 1 and Contest 2, additional information did not significantly affect results. Both illustrated a significant gap (more than 2-1) between the WTA of Authors and Buyers compared to the TB of the Buyers.
Between Contest 3 and the other Contests, the WTA/WTP gap is even larger – almost 3-1.
The study results point toward an endowment effect where owners and authors have placed a strong, and rationally unsupported bias in the valuation of the rights associated with their IP. Even where subjects were presented with different amounts of information (per Contest 1, 2 and 3), the endowment effect persisted.
As such, care must be placed when developing the complex set of rules and regulations that govern IP and their role in the market – beyond simple rational rules, policy makers must take into account the potential transaction costs instituted by the human bias resulting from the endowment effect. The authors suggest that this is even more pronounced due to the fact that in general, inventors are not well positioned to exploit their work.
Given these gaps, the authors propose several policy alternatives that may indeed mitigate the endowment effect (e.g. royalty structures, different breach remedies, patent maintenance fees). Further research is required to understand the endowment effect in more complex situations, such as where there is more substantial investment in creative effort.