Economic Analysis on Employee Invention Systemfrom the Viewpoint of R&D Incentive and Welfare Loss Arisingfrom Lawsuit against for Remuneration for Invention (*)
Research Fellow: Akitoshi MURAMOTOThis paper studies the effect of employee invention systems on economic performance by economic model(especially, property right theory). Property rights theory discusses how property rights including patents affect incentive(e.g. incentive for R&D). The purpose of employee invention systems is to affect distribution of profit from invention
between employers and employees and to promote R&D activity. We present a model that suggests that effects ofemployee inventions on distribution of profit from invention and incentive may differ depending on the difficulty inprediction of profit from invention and the size of loss caused by lawsuits. Furthermore, we study cases for anappropriate amount of remuneration and study how an appropriate amount of remuneration is calculated. We also showthat the effect of employee invention systems may differ among industries by using the results from a theoretical analysis
and case studies. Finally, we discuss what employee invention systems should be like.

IIntroduction

Invention is essential for technological development
and for economic growth. Today, most R&D activity isdone by employees who belong to a firm and conduct
R&D activity as their task. Inventions made by such
employees are called employee inventions. The Japaneseemployee invention system allows the rights to patents,
etc. to be transferred from an employee to the employer
when an invention is created. However, an employer
must pay an appropriate amount of remuneration when
the right is transferred. Many lawsuits occurred over theappropriate amount of remuneration in Japan and highamount of an appropriate amount of remuneration wasdetermined in some lawsuits. For example, in the data set
used for the case study in this paper, which consists of
105 cases related to employee invention (related to Patent
Act Article 35), appropriate amounts of remunerations aredetermined in 33 cases and more than ten million yen inseven of those and more than one hundred million yen in
two of those are determined. Many firms insisted that
the Japanese employee invention system causes amanagement risk. In Heisei 16 and Heisei 27, laws
concerning the Japanese employee invention system havebeen amended.
This paper studies how employee invention systems,
especially requirement of an appropriate amount ofremuneration, affects compensation system offered byemployers by using economic theory. The appropriate
amount of remuneration for employees is themonopolistic profit for an employer multiplied by theemployees’ ratio of contribution. If more than one

employee contributes to the invention, the appropriate
amount of remuneration for each employee is theappropriate amount of remuneration for employees
multiplied by the ratio of each employee’s contribution
among all employees. A monopolistic profit obtained
from an invention consists of two monopolistic profits.
One is a license fee, which an employer obtains by
allowing a third party to implement an invention. The
other is self-implement profit that is obtained because anemployer monopolistically implemented the invention.
One difficulty in terms of the appropriate amount ofremuneration is to predict and to measure it objectively.
This paper studies Japanese employee invention systemfrom the view point that an appropriate payment based on
self-implementation profit is difficult and generates
uncertainty due to the following reason. To calculate
self-implementation profit, we must know how large
profit is expected compared to the profit which would beobtained if the employer did not exclude third parties toimplement an invention. However, it is impossible toknow precisely how much profit would be obtained if theemployer did not exclude them. Even if an employer
estimates the self-implementation profit in some way andshe pays an appropriate amount of remuneration based on
the estimated value, the estimated value by the employer
may differ from that by the court. Hence, there is a risk oflawsuits. On the other hand, the license fee is moreobjective because it is known through license contracts.
Thus, payment based on a license fee is easier comparedto the case of self-implementation profit.
We study the employee invention system bypresenting a model adopting an approach recently(*) This is a summary of the report published under the 2014FY Industrial Property Research Promotion Project (2014FY-2016FY)
Entrusted by the Japan Patent Office.
●IIP Bulletin 2016 Vol.25

1 ●developed by a new property right theory (Hart, 2009;Muramoto, 2013). Especially focusing on the difficulty ofthe payment scheme based on self-implement profit, weexamine how a firm who faces with the uncertainty of anappropriate amount of remuneration designs acompensation scheme for employee inventions.
Furthermore, using an online legal service, we study
cases of lawsuits for an appropriate amount ofremuneration. We study how an appropriate amount of
remuneration is determined in cases and discuss theuncertainty in an appropriate amount of remuneration thatfirms face. Finally, based on the results in the case study,
we discuss the possibility that the uncertainty in an
appropriate amount of remuneration that a firm faces withdiffers among industries. Using the results of theoreticalanalysis, we predict how compensation schemes foremployee invention differs among industries.
Our study notices the difficulty of an appropriate
reward based on self-implement benefit. Among
economic theories, incomplete contract theory andproperty rights theory generally discuss the situations
where trading parties cannot sign a contract thatappropriately specifies the future contingencies.
Especially, traditional property right theory (Grossmanand Hart 1986; Hart and Moore 1990; Aghion and Tirol
1994) mainly focuses on the under-investment problem:
participants in a trade do not make effort or investment
sufficiently because they cannot obtain a sufficientamount of return for the effort and investments. In suchsituations, when a participant’s investment or effort isvery important, the participant’s investment should beenhanced by strengthening his bargaining position
depending on the level of importance of his investment oreffort compared to others and how much his investmentof effort is responsive to a financial reward for him. In thecase of an employee invention, how much an employee’sbargaining position should be protected depends on how
much his effort is important for invention compared to theemployer’s investment and how much his effort increases
when his reward increases. If the employee’s effort isvery important and his effort is very responsive to hisreward, the employee’s bargaining position should bestrengthened by a high amount of appropriate
remuneration.
As mentioned above, property rights theory mainly
focuses on the incentive problem. However, they usuallyignore economic loss caused by lawsuits and uncertainty
in lawsuits and focuses on the problem of incentive.
However, it is not enough to consider only the incentive
problem when an employee invention system is studied,
due to the following two reasons. One reason is that theobligation to pay an appropriate amount of remuneration
affects economic loss caused by lawsuits. Thus, to discuss
the desirability of the employee invention system, wemust consider the economic loss. The other reason is that●economic loss by lawsuits and uncertainty in an
appropriate amount of remuneration may affectincentives. For example, if economic loss caused bylawsuits is very large, employers may change the reward
for invention to reduce the probability of lawsuits. Thischange may affect employees’ incentives. To consider
these problems concerning economic loss by lawsuits anduncertainty, this paper adopts the approach of a newproperty right theory (Hart 2009; Muramoto 2013).
The rest of this paper is organized as follows.
Section II presents a theoretical model and analyses how
uncertainty in an appropriate amount of remuneration andinefficiency arising from lawsuits affects compensation
schemes for employee inventions offered by employers.
Section III studies cases in which the appropriate amountremuneration was certified by the court. Through thesecase studies, we clarify how the appropriate amount ofremuneration is calculated in the court and discuss
uncertainty in the appropriate amount of remuneration.
Section IV combines the results in theoretical analysis
and case studies and presents a new prediction. Section V
concludes with remarks on the desirable employee
invention system.

II Theoretical Analysis
1The Model
This section presents a model that analyzes how anemployee invention system affects the reward system thatan employer offers to an employee. In our model, theright to patent, etc. is transferred to the employer whenthe employee makes an invention. At that time, it ismandated that the employer must pay an appropriate
amount of remuneration for the invention. If the reward
for the employee is lower than the appropriate amount ofremuneration and the employee sues for it, the employer
must pay the shortage. We assume that a lawsuitgenerates an economic inefficiency (e.g. a lawsuit may
delay production).
The appropriate amount of remuneration iscomputed as the contribution ratio of an employee times
the monopolistic profit by the invention. Although morethan one employee often contributes to an invention in
the real world, we assume that only one employee
contributes to the invention in our model, for simplicity.
The appropriate amount of remuneration is the sum of
two kinds of profits. One is a license fee. The employer
obtains a license fee by allowing a third party toimplement an invention. The other is self-implementation
profit. The employer obtains such profit by implementing
the invention exclusively, i.e. he implements theinvention without allowing others to implement it.
Betweenthese
twokindsofprofits,
self-implementing profit seems to be more difficult tomeasure objectively and to be redistributed to an2 ●IIP Bulletin 2016 Vol.25

employee as an appropriate amount of remuneration. We
models the situation where the employer does not allow
third parties to implement the patented invention andimplement it exclusively and so only self-implement
profit rather than a license fee is realized. We also assume
that there is no uncertainty in the contribution ratio of an
employee determined in a lawsuit, although such
uncertainty exists in reality, as we mention in the casestudies.
The timing of the model is as follows. At period 0,
an employer offers an amount of reward,b , for aninvention. At that time, she does not know how muchself- implementation profit the invention will earn. We
assume that the amount of reward for an invention cannot
be conditional on the amount of self-implementation
profit and it is a constant value. Hereafter, we denote theprofit of self-implementation profit by π. At period 1,
an invention is realized and commercialized andself-implement profit comes to be calculated. For
simplicity, we assume that a low amount ofis realized withself-implement profit π πprobability 1 p and a high amount of self-implement
profit π π is realized with probability p . We
assume that there is no difference in the calculations
among the employer, employee, and court.
The employee decides whether to file a lawsuit ornot. If the employee does not file a lawsuit, the amount ofreward offed by the employer is paid to the employee. Letu and u be the ex post payoffs for the employer andemployee, respectively. Then,π b,ub.
u

If the employee decides to file a lawsuit, a lawsuit occurs.
Then,u1 β π λ,uβπ,
where β is the employee’s contribution ratio to theinvention (CRI, hereafter) and λ is the amount ofinefficiency arising from lawsuits. After the lawsuit, thereward for the employee is changed to the appropriate
remuneration for the invention βπ . The employer
receives π, pays the appropriate amount of remuneration,and suffers loss caused by lawsuit.
2Result
The next corollary follows the result of our model(see the analysis and Proposition 1 in II.3 in the full paperversion.)
Corollary 1: When the loss from lawsuits exceeds
the threshold level L∗ , the employer increases the award
for invention to avoid lawsuits and so the employee’s
expected payoff increases. The increases in the amount of
reward become greater as the extent of the profits’
increases. Conversely, thevariation πemployer’s expected payoff weakly decreases with theloss from lawsuits increases.
Figure 1 illustrates the relationship between theexpected profits for the employees. The vertical line
indicates the expected profits and the horizontal line
indicates the amount of loss caused by a lawsuit.

Figure 1●IIP Bulletin 2016 Vol.25

3 ●III Case Study
In Section II, we have presented a theoretical model
adopting an approach recently developed by the newproperty right theory and discussed how a firm, whofaces with uncertainty in an appropriate amount ofremuneration, offers an award scheme for employee
invention. This section studies the cases for an
appropriate amount of remuneration and examines
uncertainty in appropriate amount of remuneration firms
faces with by investigating how an appropriate amount ofremuneration is calculated in lawsuits.
We study the 105 cases of lawsuits from April 2005
to July 2015 in Japan concerning Article 35 of the Patent
Act by using an online legal service, Westlaw Japan, 33of which determine appropriate amounts of remuneration.
We found that there are four characteristics in
calculation of an appropriate amount of remuneration.
Feature 1: When the profit that an employer earned
from the invention is sufficiently high, the employee’scontribution ratio tends to be determined to be low.
Figure 2 shows that the employer’s profit frominvention and the employee’s contribution ratio that aredetermined by the court are negatively correlated.
35Employee's contribution ratio toinvention (%)

30252015
1050050

100150200250300

350

400450

Employer's benefit (100million)
Figure 2
Furthermore, we found the description that supports
Feature 1 in the judgment of cases1.
The appropriate amount of remuneration iscalculated as the profit from invention for the employer
multiplied by the employee’s contribution ratio. Thus,●Feature 1 weakens the effect on the appropriate amountof remuneration caused by the variance of the profit frominvention for the employer. However, as Feature 2 shows,Feature 1 is not so strong that it completely cancels out
the effect caused by the variance of the profit from4 ●IIP Bulletin 2016 Vol.25

invention for the employer.
We can confirm Feature 2 by Figure 3, which
illustrates the relation between employers’ benefit andamount of appropriate remuneration.

Feature 2: The higher the profit from invention for
the employer is, the higher the appropriate amount ofremuneration is calculated.
54.5

Appropriate
amount of remuneration(100million)

43.5
3
2.5
2
1.5
10.50050100150200

250

300

350

400450

Employer's benefit (100million)
Figure 3
Feature 3: When multiple patents arecomprehensively licensed, the contribution ratio of eachpatent to the comprehensive license is determined.2
As mentioned above, in principle, it is easy tomeasure a license fee objectively and pay a reward
according to the amount of license fee. However, when
the patent of a particular invention and other patents arecomprehensively licensed and a license fee is paid for allof the patents, there is a difficulty to decide the fraction
each patent contributes to the whole license fee.
Feature 4: There have been many lawsuits
concerning self-implementation profit.
In Chapter II, we modeled the situation in which
lawsuits may occur due to the difficulty in appropriate
payment according to self-implementation profit. In fact,
84 percent of the lawsuits studied in this Section concern
self-implementation profits. Furthermore, for 78 percentof the whole lawsuits, courts determine theself-implementation profit when the appropriate amountof remuneration is calculated.

●IIP Bulletin 2016 Vol.25

IV Analysis based on the results oftheoretical analysis and case study
This section studies whether the employee invention
system may have different effect depending on theindustry that the invented patent belongs to and if so, how
the effect differs. Based on the results of theoreticalanalysis and case studies, we have the following twopredictions.
Prediction 1: If an invented technology earns a hugeamount of profit with very small probability and iscommercialized without combining other patents,
uncertainty in the appropriate amount of remuneration ishigh. As a result, employees obtain high reward and theirincentive increases. On the other hand, employers’ profit
and their incentive to invest decrease.
Prediction 2: If an invented technology earns amedium amount of profit with not so small probability

and is commercialized combined with many otherpatents, uncertainty in the appropriate amount ofremuneration is low. As a result, compared to thecase mentioned in Prediction 1, employees obtain
low incentive and their incentive is low. On theother hand, employers’ profit and their incentive
to invest are high.

5 ●V Conclusion
We have studied the employee invention system byadopting the new property rights approach to model theuncertainty in appropriate remuneration and the loss
caused by lawsuits. Our results are as follows. Firstly,
theoretical analysis showed the following three. One isthat many lawsuits occur due to the difficulty to measureself-implement profit and to pay an appropriate amountof remuneration according to it. Second, an employer
pays an amount of reward that exceeds the fraction ofemployees’ contribution to the invention of the profitwhen the loss caused by lawsuits is high. Even when theemployee invention system mandates that employers pay
a reward equal to the fraction of employees’ contributionof the profit from invention, the employers tend to pay
more to avoid costly lawsuits. Third, strength of thistendency depends on the nature of the invention (e.g. theindustry that an invention belongs to).
In the case studies, we have founded the fourcharacteristics in calculation of an appropriate amount ofremuneration. Finally, in the analysis based on the resultsof theoretical analysis and case study, we have presented
prediction that how the employee invention systemaffects award schemes for employee invention may differ
depending on the nature of a patented invention,
especially the industry the invention belongs to.
Among these results, the theoretical results have thefollowing implication on the employee invention system:
the appropriate amount of remuneration should be
independent of or less depend on self-implementation
profit due to the following two reasons. First, we candecrease the probability of lawsuits by weakening thedependence on self-implementation profit. As mentionedabove, dependence of an appropriate amount ofremuneration on self-implementation profit generates
uncertainty in the appropriate amount of remunerationand induces lawsuits. If the appropriate amount ofremuneration is independent or less dependent ofself-implement profit, the uncertainty and the probabilityof lawsuits decrease. Second, the reward for invention has
upward bias: employers tends to pay more than thefraction of contribution of employees. By reducing theappropriate remunerate amount of remuneration by
self-implementation profit, the upward bias is mitigated.
It is worth noting that our analysis is limited due tothe following reasons and hence our results should beregarded as tentative. First, the approach of the newproperty right theory which we adopt in this paper is very
new and has not been sufficiently tested. Especially, theresults on the theoretical analysis depend on assumptions
we made (see II .2. (3) in the full paper version of thissummary for detail). For example, our basic model
assumes that only an employer suffers the loss caused bylawsuits. If we reassume that both employer and●employee suffer the loss caused by lawsuits, the results
may change. Furthermore, only in 32 cases of our data set,
appropriate remuneration is determined. Thus, the sample
size is very small and hence reliability of the case study
results is not high. The same is the case with the analysis
in Section IV. These points should be examined in future
research.

References
Aghion, P., and Tirole, J. (1994) “The Managementof Innovation,” Quarterly Journal of Economics, 109:1185-1207.
Grossman, S., and Hart, O. (1986) “The Costs andBenefits of Ownership: A Theory of Vertical and LateralIntegration.” Journal of Political Economy 94: 691-719.
Hart, O. (2009) “Hold-up, Asset Ownership, andReference Points.” Quarterly Journal of Economics
124(1): 267–300.
Hart, O., and Moore, J. (1990) “Property Rights andthe Nature of the Firm.” Journal of Political Economy 98:1119-1158.
Muramoto, A. (2013) “Strategic Determination ofRenegotiation Costs” KIER Working Papers No 877.

12Tokyo District Court Judgment 2006 (Hanji)1948. See the fullpaper version of this summarized report for detail.
Tokyo District Court 2007 (Hanji) 1971.

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