The real picture behind patenting and firm performance

A new study published recently in the International Small Business Journal suggests that patenting has a negative effect to startup performance.
Gavin Reid of Cambridge University and Bernadette Power of University College Ireland analyzed the performance of 32,649 (3,869 high-tech, 7,574 medium-tech and 21,026 non-tech) startups based on data taken during the 2005 and 2012 Kaufmann Firm Surveys. The study explored the effect to multidimensional firm performance of protecting a firm’s intellectual property (IP) using patents, copyright, or trademarks and their licensing as single or combined assets. Firm performance was modeled as a composite performance indicator across eight dimensions, namely, perceived competitive advantage, assets, size, sales, return on equity, profit, rate of profitability, and survival. The relationship between firm performance and type or licensing of IP was estimated using an ordered probit analysis—a type of regression analysis applied to dependent variables with multiple ordered categories (or dimensions, as identified above).
Power and Reid conclude that patenting has a significant negative impact to multidimensional firm performance. They explain that these results corroborate findings from previous studies that high performance startups do not favor patenting because the cost of registration and enforcement outweigh potential revenue. The negative impact persists even when synergy between combined copyright and patent use or combined trademark and patent use are considered. However, a positive effect of patenting is observed when the time lag it takes for patents to impact performance is considered, thus suggesting that startups can still reap the benefits of patents after surviving three years.
The effect of patenting to firm performance is a longstanding question among economists and business scientists. Many studies have and continue to investigate whether the prevailing idea that patents have a quality-signaling effect and therefore attracts capital is a realistic argument for patenting.
In 2009, Helmers and Rogers of Oxford University published a paper reporting the results of their study that set out to capture the effect of patenting to the performance of 303 UK-registered startups in medium- and high-tech industries that filed a UK patent between 1999 to 2001. Here annual asset growth rate was measured from 2001 to 2005. These numbers were then benchmarked against the growth rate of a control group of similar-aged non-patenting firms. The study found that patenting startups grew more than their non-patenting counterparts by a 6-8% annual difference. The authors however failed to elucidate if a patent’s ability to signal quality and attract financing caused the observed asset growth.
Patenting not only has a positive effect to firm performance, but also correlates to higher survivability, as shown by Cockburn and Wagner in 2007. During the dot-com crash of the late `90s, a number of Internet-related firms filed business method or software patents following a US Supreme Court decision that clarified the patentability of these subject matters. Cockburn and Wagner looked into the survivability of 356 internet-related or computer software firms that reached initial public offering (IPO) status in the NASDAQ stock exchange between 1998 and 2001. They employed a multivariate analysis on the dependence on patenting of the period between a firm’s IPO to its delisting. They find that firms that filed a number of patent applications delisted later than non-patenting firms. Survivability was found to further correlate with having obtained venture capital financing before reaching IPO. These results further suggest a causal link between patenting, financing, and growth or survivability.
Farre-Mensa, Hegde, and Ljungqvist determined this causal link between patent and startup growth in 2016 by looking into the approval history of 45,817 first-time local patent applications by US startups and found that having a first registered patent increases the startup’s ability to raise funding by 53% proving a patent’s ability to signal quality to investors. Subsequently, this cash injection was used by startups to grow their firms in terms of employment by 36% over the next five years. This then translated to sales growing by 51%. The probability for the startup to reach IPO status also doubled with a first patent granted. These surprising insights were welcomed during its publication which coincided with academics’ call for the reform of the US patent system in light of studies arguing that it stifles rather than incentivizes innovation.
Beyond the IPO stage, firm performance (as represented by stock performance) is still impacted by patenting. A study yet to be published in the latest issue of the Journal of Accounting and Economics indicates that innovation disclosures by startup firms in their patent applications are understood by investors as a signal of increased risk thus affecting the firm’s stock price and cost of equity. The large risk of return allowed for these small innovative firms to enjoy a positive and significant “innovation premium” that lasted up to five years.
In light of these evidence for patenting, how then should we weigh and interpret the results of Power and Reid? For one, contrary to their claim that the positive impact of patenting to firm performance is mainly observed in studies of large, mature firms, this impact has been documented in many studies of small and early-stage companies. A salient point raised in their discussion that seems to explain their result is that the impact of patenting to firm performance may differ by firm sector or industry. Previous studies cited in the above discussion utilized a dataset of startups that are considered medium- to high-tech, which implies that tech-focused firms are more likely to patent than non-tech firms. Perhaps Power and Reid’s results are reflective of the fact that most of their startups were non-tech and that for these firms patenting provides no additional value. If this was the case, then clearly more in-depth studies must be made to investigate the effect of patenting to the performance of firms in various industries.
Despite the negative conclusion regarding patenting, the main contribution of Power and Reid is an analysis of the effect of different IP management strategies to firm performance especially on the effect of the synergy between the use and licensing of different IP rights. Power and Reid reported that the complementary use or licensing of different IP types did not necessarily improve firm performance. For example, a startup that owned a lot of trademarks and licenses them experienced a decrease in revenue. In contrast, the complementary effect of owning a lot of patents or copyrights and subsequently licensing them increased revenue. Another interesting insight they found was that combining the licensing of patents with copyright yielded a significant positive effect to firm performance unlike that of licensing patents with trademarks. These results are important from an IP manager’s perspective in considering what strategy to take i.e. whether to license an IP as a single asset or to combine it with the licensing of a different IP type.
More details still have to be unraveled regarding the mechanism underlying the effect of IP or patenting specifically to firm performance. As mentioned earlier, the patenting (or non-patenting) strategy of startups belonging to different industries is worth investigating for us to catch a glimpse of the real picture across industries. Once we take hold of the real picture behind the effect of patenting to startups for different industries, practitioners can better advise startup founders and provide a more grounded and realistic IP strategy. Hopefully, future researchers will be inspired to pursue this question.

Main reference:

Power, B., & Reid, G. C. (2021). The impact of intellectual property types on the performance of business start-ups in the United States. International Small Business Journal, 39(4), 372–400.

Papers cited:

Helmers, C., & Rogers, M. (2011). Does patenting help high-tech start-ups? Research Policy40(7), 1016–1027. doi:10.1016/j.respol.2011.05.003

Wagner, S., & Cockburn, I. (2010). Patents and the survival of Internet-related IPOs. Research Policy39(2), 214–228. doi:10.1016/j.respol.2009.12.003
Farre-Mensa, J., Hegde, D., & Ljungqvist, A. (2020). What Is a Patent Worth? Evidence from the U.S. Patent “Lottery”. The Journal of Finance75(2), 639–682. doi:10.1111/jofi.12867
Stoffman, N., Woeppel, M., & Yavuz, M. D. (2022). Small innovators: No risk, No return. Journal of Accounting and Economics, 101492. doi:10.1016/j.jacceco.2022.101492