Field-of-use restrictions in licensing agreements

A widely used clause in license contracts – the field-of-use restriction (FOUR) – precludes licensees from operating outside of the technical field specified. When a technology has several distinct applications, FOUR allow the licensor to divide up his rights and attribute them to the lowest-cost producer in each field of use. This can improve production efficiency. With complex technologies, however, the boundaries of fields of use may be difficult to codify, entailing a risk of licensees' rights overlapping. We explore how this affects the optimal license contract in a moral hazard framework where the licensor's effort determines the probability of overlap. We show that depending on the contracting environment, the license agreement may include output restrictions and non‐linear royalty schemes.