Pay-for-delay settlements and patent expansion practices

Pay-for-delay (reverse payments) settlements and patent expansion practices (PEP), such as preemptive patenting, product hopping and evergreening, have been criticized for their potential anticompetitive effects. This paper shows that reverse payments and PEP are strategic substitutes and, when the information over the patents’ strength is asymmetric and patents’ strength is endogenous, a ban on reverse payments may reduce consumer surplus. This effect is stronger the more generic competition reduces industry profits. When the cost of using PEP is sufficiently high, a ban on reverse payments is optimal, otherwise it is optimal to allow reverse payments at the minimal level consistent with the originator not engaging in PEP. Results are qualitatively robust to allowing PEP to increase patent quality and consumer surplus.