CFA Institute Journal Review summarizes "What Is a Patent Worth? Evidence from the U.S. Patent 'Lottery'," by Joan Farre-Mensa, Deepak Hegde, and Alexander Ljungqvist, published in The Journal of Finance, April 2020.
The authors of this research estimate the value of patents granted to startup firms. The authors also explore the factors driving the real effects of a patent’s value.
What Is the Investment Issue?
The value of one’s legal property rights to an invention is distinct from the value of the invention itself; it is the value over and above that resulting from the underlying invention. A patent’s value lies in the incremental economic benefit that exceeds what the patent holder would earn if the invention were not patented, but distinguishing this additional benefit from the underlying invention’s economic value is difficult. Firms that have a large number of patents reveal large increases in firm value, but such increases reflect the combined value of both the patents and the underlying technology. Intel’s growth in value in the 1990s, for example, was due more to the company’s technology than its patents. The costs of winning and defending patents can actually offset any advantages they confer; in fact, some companies opt to not pursue patents and to protect their inventions via trade secrets or other methods.
How Did the Authors Conduct This Research?
To identify the value of holding patents, researchers have historically analyzed the difference between firms with patents and those without, but such analyses do not distinguish between the effect of the patents and the value of the underlying innovations. This is because the researchers were unable to obtain data on patent rejections. For this study, the authors were able to access the internal databases of the United States Patent and Trademark Office, which allowed them to investigate both granted and rejected patent applications.
In addition, the authors take into account the quasi-random process by which patents are reviewed and approved. Despite the huge impact a patent can have on a startup’s fortune, the approval process has a not-insignificant “luck of the draw” element to it. Some examiners are significantly and systematically more lenient in granting approvals, and the patentability of certain inventions can leave considerable room for disagreement. As a result, the process can seem lottery-like, with some applications winning approval solely because they were assessed by more lenient examiners. Comparing patent winners with patent losers whose underlying innovations are only randomly different suggests that the beneficial impacts experienced by the former must be due to the patent.
What Are the Findings and Implications for Investors and Investment Professionals?
Approval of a startup’s first patent application, which is influenced by the leniency of the assigned examiner, appears to have a significant impact on a company’s subsequent five-year employment growth (54%), five-year sales growth (79.5%), and follow-on innovation. However, to hold constant the potential impact of exogenous factors, the authors focused their research on smaller startups, so that the results are not generalizable to mid- and large-cap companies. Patents award temporary monopoly rights over inventions, but—given the delay between a product’s patent acquisition and its launch—their value is probably greatest and most immediate as a bargaining chip in licensing negotiations and in helping startups secure capital from banks, public investors, and venture capitalists. Attracting customers and deterring copycats is important, but these concerns would be more applicable to more mature companies.