Patent thickets, stock returns, and conditional CAPM

By Po-Hsuan Hsu, Hsiao-Hui Lee, and Tong Zhou

In order to accelerate knowledge accumulation and technical progress, governments introduced patent systems to encourage inventors to share their ideas, discoveries, and inventions with the public. In exchange for their disclosure, inventors are granted exclusive use rights of patented new knowledge for a certain period. Patent rights, however, could overlap. Because of the accumulation of patents and increasing integration of technologies, overlapping patent rights have become common in a number of technology areas. This increasingly widespread overlap, often referred to as a “patent thicket” (Shapiro 2000, Ziedonis 2004, Galasso and Schankerman 2010), makes it difficult for patentees to commercialize their patents when the ownership of overlapping patent rights is fragmented. An “anti-common tragedy” due to patent thickets has occurred in many high-tech industries (Heller and Eisenberg 1998).

Some practitioners argue that, under patent thickets, procuring a complete set of licenses is a daunting bargaining challenge and deters firms from realizing their growth potential. To statistically test this hypothesis and assess its general implications for corporate activities, we utilize the full sample of publicly listed U.S. firms and their patent filings, patent litigations, new product announcements, and accounting data. We find supportive evidence that firms confronted by deeper patent thickets are associated with higher commercialization costs (measured by the frequency of being sued for patent infringement), slower patent commercialization (measured by the number of new products relative to the number of granted patents), and lower profitability in the future.

We move one step further and examine the implications of patent thickets for financial markets. Specifically, we find a negative relation between a firm’s patent thicket and its subsequent stock returns as estimated by a Conditional Asset Pricing Model (CAPM)—firms in the top quintile of patent thickets underperform those of firms in the bottom quintile by 0.28% and 0.41% in two different portfolios based on patent thickets. The economic intuition behind this return difference is that patent thickets reduce firms’ possibilities in commercializing their patents and thus hurt firms’ growth opportunities—which are the key component of stock pricing. We also find that, when there is better coordination among patent owners, patent thickets become less of a concern. More importantly, we develop a general equilibrium model that justifies the aforementioned economic intuition and formalizes the role of patent thickets in financial markets.

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