How Do Inventors Respond to Financial Incentives? Evidence fromUnanticipated Court Decisions on Employees’ Inventions in Japan

We use a novel panel data set of corporate inventors matched with their employersin Japan to examine the effects of output-based financial incentives oncorporate inventors’ performance. We exploit heterogeneous industry responses toJapanese court decisions that forced Japanese firms to introduce strongerincentives. We show, first, that only industries facing a high risk ofemployee-inventor lawsuits adopted or significantly strengthened financialincentives based on the commercial success of inventions in response to thecourt decisions. Our estimations reveal that stronger financial incentives insuch industries reduced the number of highly cited patents and significantlydecreased the incidence of science-based patents after technology-specific yeareffects are controlled for. These results show that the compulsion to remunerateemployee-inventors on the basis of the commercial success of their inventionscould distort the efficiency of corporate research and development andillustrate the importance of contracting freedom.