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Innovation and Reverse Payments

I consider settlements of patent litigation between a branded drug maker and its generic challenger that include a promise by the generic maker to stay out of the market, sometimes in exchange for a “reverse payment.” These settlements increase the profits of branded drug makers. Their defenders argue that this permits greater investment in innovation, which ultimately makes consumers better off. I use a model that incorporates gains from innovation to show that, contrary to intuition, these settlements still harm consumers once innovation is taken into account and either antitrust should ban them or the Federal Trade Commission should intervene in settlement negotiations on behalf of consumers.