Modularity and intellectual property protection

Modularity is a means of partitioning technical knowledge about a product or process. When state-anctioned intellectual property (IP) rights are ineffective or costly to enforce, modularity can be used to hide information and thus protect IP. We investigate the impact of modularity on IP protection by formally modeling the threat of expropriation by agents. The principal has three options to address this threat: doing nothing, licensing the focal IP ex ante, and paying agents to stay loyal. His optimal choice depends on external parameters--the share of untrustworthy agents in the population, the intensity of competition in duopoly, and the degree of complementarity in the system. We show how the principal can influence the value of these options by modularizing the technical system and by hiring clans of agents, thus exploiting relationships among them. Extensions of the model can be used to incorporate screening and signaling in the hiring process, the effect of an imperfect legal system, and social norms of fairness. We illustrate our arguments with examples from practice.