Examining the Role of Patents in Firm Financing

Just this morning, an interesting new literature review came to my mailbox via SSRN. In Is There a Role for Patents in the Financing of New Innovative Firms?, Bronwyn Hall (Berkeley economics) provides an extremely thorough, extremely helpful literature review on the subject. It's on SSRN, and the abstract is here:

It is argued by many that one of the benefits of the patent system is that it creates a property right to invention that enables firms to obtain financing for the development of that invention. In this paper, I review the reasons why ownership of knowledge assets might be useful in attracting finance and then survey the empirical evidence on patent ownership and its impact on the ability of firms to obtain further financing at different stages of their development, both starting up and after becoming established. Studies that attempt to separately identify the role of patent rights and the underlying quality of the associated innovation(s) will be emphasized, although these are rather rare.

This paper caught my eye for a few reasons.

First, I'm working on a paper on this topic right now, using a high quality dataset that nobody has been able to exploit for this question. I hope my coauthor (David Ratigan, an economist here at Villanova) and I can do so! Hall's paper lays out some of the challenges we face, and the primary criticism of prior papers: whether the benefit of financing is simply the patent right, or instead the underlying quality of the invention. Professor Hall suggests that the best approach may be a detailed study of companies with unpatented inventions as compared to companies with patented inventions. I think it would be great, but really difficult, to do such a study. But I'm not convinced it is necessary with the proper random sample and controls. We'll find out, because that's what we're trying to do. Even if we fail, I think there is value in knowing the role of the patent right even if it is simply a proxy signal - more on this theoretical question below.

Second, I think it would be good for law folks to read this. This is not a literature I hear discussed or cited very often.

Third, Professor Hall and I seem to agree that the best in class for these studies is What is a Patent Worth? Evidence from the U.S. Patent Lottery. Professor Hall cites to a prior draft, called the Bright Side of Patents, which I blogged about here. Related, and more personally, I have all the same papers in my literature review, so I'm feeling glad that I didn't miss any.

In the end, there are a few theoretical divides that affect how these studies are done: Do we look only at those firms who received venture capital? Do we look at the fact of investment or the amount? Does final outcome matter, or just financing? Is signaling sufficient, or should we care if the signal is accurate?

This last question is the most important, and the one highlighted in this literature review. Must we separate the patent right from the patent innovation in order to determine that the patent system has value? Whenever I have propounded this theory of patenting, that's the pushback I get - that the patent is just a correlated signal with firm quality, so the patent doesn't have any real value on its own (this pushback even implies that the patent right has little value). But imagine a world where there is no patent system and firms innovate. How would they signal their quality? The method doesn't really matter, except to note that those very same firms that don't patent now can signal their quality in the exact same way. And so the question becomes threefold in my view:

1. If firms are able to signal their quality without patents, then shouldn't we expect to find random distribution of financing among firms with patents and firms without?
2. If firms are not able to signal their quality without patents, then is that a sufficient justification for the patent system--a quality signal?
3. Do we live in a world where firms could signal their quality without patents, but the patent system drowns them out as a "supersignal" (for better or worse)?

Some food for thought on this topic.