Strategic Acquisitions and Investments in a Duopoly Patent Race under Uncertainty

This paper uses a continuous-time real-options patent-race model to study a patent-race game in which a firm with larger research bandwidth competes with a firm with smaller bandwidth. The large firm can make strategic acquisitions or investments in the small firm subject to transactions costs. Acquisitions occur when the small firm is about to make pre-emptive investments or the large firm has set-backs and the two firms are about to enter head-to-head competition. Strategic investments tend to occur when the smaller leader has technological setbacks. Our continuoustime approach shows that some rich strategic play can occur. This paper uses a continuous-time real-options patent-race model to study a patent-race game in which a firm with larger research bandwidth competes with a firm with smaller bandwidth in an environment with multiple sources of uncertainty. The large firm makes take-it-or-leave-it offers to the small firm’s owner for all (acquisitions) or part (strategic investments) of the small firm’s equity, but exogenously imposed transactions costs make such transactions costly. Each firm chooses an investment rate at which it pursues the ∗ Mailing address for both Kyle and Meng is Fuqua School of Business, One Towerview Drive, Duke University, Durham, NC 27708. Email address for Kyle is [email protected] and email address for Meng is [email protected]. We thank Itay Goldstein, Campbell R. Harvey, Leslie M. Marx, Richmond Mathews, Hui Ou-yang, Curtis R. Taylor, S. Viswanathan, and seminar participants at Duke, NYU, and the FMA for their helpful comments and discussions. All errors are our own.