Efficient Compensation for Employees' Inventions: An Economic Analysis of a Legal Reform in Germany

The German law on employees' inventions requires employees to report to their employer any invention made in relation with the work contract. An employer claiming the right to the invention is obliged to pay a compensation to the employee. Up to now, this compensation is a matter of negotiations. A reform proposal seeks to introduce a combination of a fixed payment and a share of the project value. Regulations like this can also be found at U.S. universities. Up to now, German scholars enjoyed the privilege of not having to report their inventions to their universities. The new German law concerning inventions made by university scholars has abolished this privilege. Universities now have the right to claim the invention in exchange for a mandatory 30-percent share of the project value. Our model draws on Principal-Agent theory and combines elements of moral hazard and hold-up. We derive a unique efficient payment scheme that consists only of a lump-sum payment. We show that freedom to negotiate over the compensation after the invention has been done provides inefficient incentives. Efficient incentives would require the compensation to be fixed ex-ante, as it is provided by both the proposed law (concerning employees in general) and the new law (concerning university scholars). However, both set the payment schemes in an inefficient way. With suboptimal incentives to spend effort into inventions, the government's goal, an increase in the number of patents, is likely to be missed.