Understanding Technology Licensing Through the Lens of New Institutional Economics

Licensing Tech Without Losing Control: Smart Contracts and Smarter Institution

Technology licensing👉 Permission to use a right or asset granted by its owner. is a vital yet complex element in modern economies. Companies often share or acquire technology to innovate, stay competitive, and expand their market reach. However, the transfer of intangible assets like knowledge and intellectual property👉 Creations of the mind protected by legal rights. comes with significant risks. The paper by Brousseau, Coeurderoy, and Chaserant explores how companies structure licensing contracts to manage these risks and what lessons New Institutional Economics (NIE)👉 Study of how institutions shape economic behaviour and outcomes. can offer to optimize these agreements.

What Is a License?

At its core, a license is a legal agreement that allows one party (the licensee) to use intellectual property (IP) owned by another (the licensor). These agreements are especially common in the transfer of technology and knowledge, where one firm grants another the right to use patented inventions, proprietary processes, or technical know-how in exchange for royalties or other benefits.

In technology markets, licensing plays a dual role: it’s a tool for monetization and a mechanism for diffusion. However, these benefits come with risks. Once knowledge is transferred, it can’t be “unlearned.” The licensee might misuse or strategically underuse the technology, or even become a competitor. As a result, licensing contracts must be carefully crafted to guard against opportunistic behaviour, protect proprietary knowledge, and allow adaptability over time.

The challenge is heightened by the intangible nature of knowledge and its partial legal protection. That’s where contract governance and institutional context become crucial.

What Types of Licenses Are There?

Technology licensing agreements (TLAs) come in various forms, distinguished by the scope of rights granted and the nature of the relationship. The main categories include:

• Sole Licenses: Only the licensee and licensor can use the technology.
• Exclusive Licenses: Only the licensee can use it, even excluding the licensor.
• Non-exclusive Licenses: Multiple entities can license the same technology.

Licenses can also be standalone contracts or embedded within broader strategic alliances, R&D partnerships, or joint ventures. The complexity increases when knowledge is accompanied by the transfer of tacit components—such as training, prototypes, or proprietary tools—making the agreement resemble a hybrid between a contract and an organizational form.

The paper’s empirical data (213 contracts from US, Europe, and Japan) reveals a rich variety in licensing structures, each tailored to specific transaction characteristics, institutional settings, and strategic goals.

What Are Important License Terms?

Three key elements emerge as critical for the governance of licensing agreements:

1. Supervision Clauses
   These enable licensors to monitor how the licensee uses the technology—whether through audits of books, inspections of products, or site visits. They’re vital when large sunk investments or proprietary knowledge are involved, particularly if the licensee could become a competitor.

Surprisingly, the study finds that the presence of supervision provisions is not universal. They are more likely when:

• The transfer involves intensive knowledge (e.g., tacit components).
• The licensee operates in a similar market (raising competitive risks).
• The institutional environment—especially the legal system—enables effective enforcement.

Supervision is a safeguard, but only if breaches can be credibly penalized.

2. Renegotiation Clauses
   These clauses permit adjustments to the contract post-signature, responding to technological changes, evolving markets, or unforeseen events. They’re essential in long-term or high-uncertainty contracts, where locking into rigid terms could be risky.

Key findings include:

• Renegotiation is more likely when contracts include renewal provisions or when uncertainty is anticipated.
• Private institutions (like trade associations) facilitate renegotiation by fostering trust and shared norms.
• Renegotiation boosts flexibility but can undermine commitment if not managed well.

3. Dispute Resolution Mechanisms
   These determine how conflicts are settled—through courts, arbitration, or specialized committees. Given the sensitive nature of technology and the limits of public courts in understanding technical details, many firms prefer Alternative Dispute Resolution (ADR)👉 ADR resolves conflicts outside of court via mediation or arbitration. methods.

Key takeaways:

• ADR is preferred when tacit knowledge is involved, and confidentiality is critical.
• It’s most effective when private institutions or industry norms exist to support enforcement.
• ADR use is less likely when uncertainty is too high or when firms are vertically integrated (e.g., parent-subsidiary relationships).

In short, the structure of governance clauses is shaped by a mix of transactional hazards, institutional capacities, and strategic dynamics.

How to Use New Institutional Economics to Optimize Licensing Agreements

Technology licensing agreements are more than just legal documents—they are complex governance tools crafted under uncertainty, strategic tension, and institutional constraints. This is where New Institutional Economics (NIE) offers powerful insights. NIE doesn’t just ask what terms go into a contract—it asks why certain clauses are chosen over others, and how institutions and transaction characteristics shape these choices.

What Is New Institutional Economics (NIE)?

At its core, NIE is a framework that studies economic behaviour within institutional contexts—that is, the legal, social, and organizational rules that shape interactions. It’s concerned with:

• Property rights: How rights are defined, allocated, and enforced.
• Transaction costs: The costs of exchanging goods or services beyond the price—think negotiation, monitoring, enforcement.
• Agency relationships: How to align interests between parties with asymmetric information or incentives.
• Institutional environments: The role of legal systems, private governance, and norms in shaping economic exchange.

In licensing, where knowledge is intangible, appropriable, and often embedded in trust, NIE offers a practical toolkit for reducing risk👉 The probability of adverse outcomes due to uncertainty in future events. and fostering cooperation.

Why Does NIE Matter for Licensing?

Licensing agreements are often struck in high-risk, high-uncertainty environments:

• Knowledge can’t be “un-transferred” once shared.
• The licensee may turn into a rival.
• Courts may not understand or enforce contract terms effectively.
• The legal system may be too slow, costly, or fragmented across jurisdictions.

Firms, therefore, build contracts not just to formalize an exchange, but to govern a relationship over time. NIE shows that the structure of these contracts is shaped by three key elements: the nature of the transaction, the institutional environment, and the strategic behaviour of the actors involved.

Let’s explore how NIE’s three main branches—Property Rights Theory, Transaction Cost Economics, and Agency Theory—can guide smarter, more resilient licensing agreements.

Property Rights Theory: Clarify and Protect Ownership

Property rights theory👉 Study of how ownership rights affect economic efficiency. emphasizes the need to define, allocate, and enforce ownership over assets—especially intangible ones like knowledge.

Recommendations:

• Clearly define who owns what, especially improvements or spin-offs derived from licensed technology.  Licensing agreements should explicitly state the boundaries of ownership, not just for the original technology but also for any derivative innovations. This clarity prevents disputes down the line and ensures both parties understand their rights to future revenue or use. Without clear definitions, valuable improvements might become legal grey areas, leading to conflict or lost opportunities.
• Use grant-back clauses to reclaim improvements made by licensees. A grant-back clause ensures that if the licensee develops enhancements or adaptations based on the original technology, the licensor can access or benefit from them. This protects the licensor’s competitive position and encourages innovation👉 Practical application of new ideas to create value. without losing control. It also incentivizes collaboration by giving both parties a stake in continuous development.
• Secure warranties from the licensor (e.g., ownership, non-infringement) to protect the licensee. Warranties provide legal assurance that the licensor actually owns the technology and that its use won’t infringe on third-party rights. This protects the licensee from unexpected lawsuits and financial liabilities. It also signals the licensor’s confidence in their IP, making the agreement more trustworthy and secure.
• Leverage private institutions to complement incomplete legal systems, particularly in countries with weaker IP enforcement. In jurisdictions where public enforcement of IP rights is slow or unreliable, private institutions—like industry associations or arbitration panels—can provide dispute resolution and standard-setting. These bodies create a framework of trust and accountability beyond what courts can offer. Relying on them reduces transaction costs and enhances the enforceability of contracts in challenging legal environments.

A well-structured property rights regime ensures licensors are incentivized to share, and licensees are confident enough to invest.

Transaction Cost Theory: Match Governance to Risk

Transaction cost economics (TCE) focuses on minimizing the costs of coordinating and safeguarding exchanges. High transaction costs emerge when there are:

• Asset specificity (e.g., heavy knowledge transfer). When a licensor invests significant time and resources into transferring specialized knowledge, those assets become highly specific to the transaction. This creates a dependency, as the licensor cannot easily repurpose or retrieve the shared know-how if the relationship breaks down. Because of this lock-in effect, contracts must include safeguards like supervision clauses or milestone-based payments to protect the licensor’s investment.
• Opportunistic threats (e.g., licensee as future rival). A licensee may use the acquired technology not just as agreed, but to compete against the licensor by developing similar or improved products. This strategic behaviour—such as “inventing around” the licensed IP or stalling technology deployment—poses serious risks to the licensor’s market position. To counter this, contracts should include performance requirements, field-of-use restrictions, and clawback clauses that discourage opportunism.
• Uncertainty (e.g., evolving technology). Technology markets evolve rapidly, and what seems valuable today may become obsolete tomorrow due to innovation, regulation, or shifts in demand. This makes it difficult to predict future conditions or write fully complete contracts at the outset. To handle this, licensing agreements should include renegotiation provisions or flexible terms that allow adaptation without renegotiating the entire deal from scratch.

Recommendations:

• Use supervision clauses when knowledge is specific, and stakes are high. When the transferred knowledge is tailored to the licensee and cannot be easily reused elsewhere, the licensor is exposed to greater risk. Supervision clauses—such as audit rights or site inspections—help monitor compliance and discourage misuse. They provide an added layer of control, especially when valuable intellectual property or trade secrets are involved.
• Implement renegotiation mechanisms when contracts are long-term and unpredictable. Alternative Dispute Resolution (ADR) methods, like arbitration, are often faster, more confidential, and better suited for resolving technical disagreements than public courts. When intellectual property is involved, privacy and specialized expertise are essential to protect both value and competitive advantage. ADR also tends to preserve business relationships by avoiding adversarial legal battles.
• Prefer ADR in contexts with high complexity or sensitive IP. Alternative Dispute Resolution (ADR) methods, like arbitration, are often faster, more confidential, and better suited for resolving technical disagreements than public courts. When intellectual property is involved, privacy and specialized expertise are essential to protect both value and competitive advantage. ADR also tends to preserve business relationships by avoiding adversarial legal battles.
• Avoid over-engineering contracts in low-risk or short-term relationships. In simple or short-duration deals, overly complex governance structures can drive up negotiation and enforcement costs unnecessarily. Instead, streamlined contracts with clear, minimal terms are often more efficient and effective. It’s about matching the contract’s design to the actual level of risk and uncertainty, not creating legal overkill.

The goal is to balance contractual control with flexibility—tighten where hazards are high, loosen where collaboration is smooth.

Agency Theory: Align Incentives and Monitor Behaviour

Agency theory👉 Study of conflicts and incentives between principals and agents. deals with conflicts of interest between principals (licensors) and agents (licensees). Since the licensee might shirk or act against the licensor’s interests, monitoring and incentive alignment are crucial.

Recommendations:

• Design royalty structures (e.g., variable royalties) to align effort and outcomes. Royalty structures should incentivize the licensee to actively commercialize the technology and maximize its value. Variable royalties—such as those tied to sales volume or revenue—encourage performance by linking payment directly to success. This alignment ensures that both licensor and licensee benefit proportionally from the licensee’s effort and market performance.
• Use minimum performance clauses to prevent licensees from under-using the technology. Minimum performance clauses set a baseline expectation for how the licensee will exploit the technology, whether through production, sales, or revenue targets. These provisions prevent strategic underuse, such as when a licensee acquires rights to suppress a competing innovation. If the minimum thresholds aren’t met, the licensor may have the right to revoke the license or renegotiate terms.
• Deploy supervision rights where there’s a risk of moral hazard. When licensees have discretion over how they use the licensed IP, there’s a risk they may act in ways that benefit themselves at the licensor’s expense. Supervision rights—like audits or inspections—help monitor behaviour and verify that obligations are being met. They serve as both a deterrent and a means of early intervention if problems arise.
• Where trust or alignment is low, limit the scope of the license or include termination clauses. In relationships lacking strong alignment or mutual trust, it’s safer to restrict the license’s geographic, temporal, or application scope. Narrowing the license reduces exposure and makes breaches easier to manage. Including termination clauses also gives the licensor leverage to exit the agreement if the licensee deviates from expectations or acts opportunistically.

Agency theory highlights the importance of building in feedback and enforcement mechanisms, especially when the licensor has limited visibility post-transfer.

Final Remarks: Markets for Technology Need Institutions

The study provides a nuanced, empirically grounded view of how firms manage the governance of licensing contracts. One of the key conclusions is that private institutions—such as trade associations and industry guidelines—play a pivotal role in enabling efficient contracting. These institutions help firms:

• Coordinate expectations.
• Lower enforcement costs.
• Share information and establish norms.

In a world where public institutions cannot keep up with fast-evolving technology, private governance fills the gap. Policymakers should therefore support the development of these institutions, not stifle them under antitrust concerns.

Ultimately, effective licensing requires more than legal drafting—it demands a strategic blend of governance tools, adapted to the nature of the transaction, the risk environment, and the broader institutional context. This paper offers both theoretical depth and practical guidance to anyone looking to navigate the complex world of technology licensing.