When Settlements Increase Competition: Reverse Payment Settlements and Market Entry

Abstract: In recent years, the Federal Trade Commission has requested that courts refuse to enforce so-called “reverse payment settlements”, or settlements in which the patent holder pays the competition to settle and exit the market, on the grounds that they are “anticompetitive”. We show that when potential entrants and patent holders possess private information concerning patent strength, it is possible for the existence of reverse payment settlements to increase competition. While such settlements do decrease competition conditional on entry, they also incentivize entry by increasing the range of possible patent validity under which a competitor can expect a positive payout. We define conditions on the ex-ante distribution of patent strength such that each effect dominates.