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«THE MARKET VALUE OF PATENTS AND R&D: EVIDENCE FROM EUROPEAN FIRMS Bronwyn H. Hall Grid Thoma Salvatore Torrisi Working Paper 13426 ...»

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Bronwyn H. Hall

Grid Thoma

Salvatore Torrisi

Working Paper 13426



1050 Massachusetts Avenue Cambridge, MA 02138 September 2007 We thank Rishab Ghosh and the participants in the EC DG IT study on "The effects of allowing patents claims for computer-implemented inventions" for discussing with us several issues concerning patents and IPR. Moreover, we would like to thank Armando Benincasa from Bureau Van Dijk, Elvio Ciccardini, and Gianluca Tarasconi from CESPRI - Bocconi University for their valuable assistance in data collection.

Colin Webb has provided us with data on citations to EPO patents. Comments from seminar and conference participants at CESPRI-Bocconi University, NBER, the Dept of Management of Carlos III University, the Department of Management of Bologna University, and the OECD have also been helpful in producing the current revision. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.

© 2007 by Bronwyn H. Hall, Grid Thoma, and Salvatore Torrisi. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

The market value of patents and R&D: Evidence from European firms Bronwyn H. Hall, Grid Thoma, and Salvatore Torrisi NBER Working Paper No. 13426 September 2007 JEL No. D24,G32,L86,O31,O34


This paper provides novel empirical evidence on the private value of patents and R&D in European firms during the period 1991-2004. We explore the relationship between firm's stock market value, patents, and "quality"-weighted patents issued by the European Patent Office (EPO) and the US Patent and Trademark Office (USPTO). We find that Tobin's q is positively and significantly associated with R&D and patent stocks, but that only those patents taken out in both patent offices or at the USPTO alone seem to be valued. Either forward citations or a composite quality indicator based on forward citations, family size and the number of technical fields covered by the patent are modestly informative for value. Software patents account for a rising share of total patents in the USPTO and EPO. Moreover, some scholars of innovation and intellectual property rights argue that software and business methods patents on average are of poor quality and that these patents are applied for merely to build portfolios rather than for protection of real inventions. We found that such patents are considerably more valuable than ordinary patents, especially if they are taken out in the U.S. However their quality indicators are no more valuable than those of other patents, suggesting that their primary purpose may be to increase the size of the patent portfolio.

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1. Introduction Measuring the private returns to investment in innovation or knowledge assets is important both to firms and to economists who wish to assess and compare firm performance in this area. At the aggregate firm level, the primary methods for obtaining quantitative measures of these returns relate profits, revenue, or the market value of the firm to observable measures of innovation investment such as R&D or patents. This paper contributes to this literature by providing novel empirical evidence on the value of a number of different measures based on the patenting activities of European firms, both in Europe and in the United States.

In addition to the goal of measuring innovative assets in European firms, our investigation is motivated by an interest in several issues related directly to the patents themselves. First, we hope to gain a deeper understanding of the ‘patent paradox’, that is, the fact that the number of patent applications to the USPTO and the EPO continues to grow despite the weakness of patents as an instrument for protecting innovation, documented in various surveys of innovators in a number of different industries and countries (Levin et al 1987; Cohen, Nelson and Walsh, 2000; Arundel 2001, 2003). Previous studies have demonstrated that the distribution of patent technical and economic value is very skewed with only a few patents yielding a significant value to their owners (Harhoff et al. 1999). Some argue that the lower barriers to patenting are responsible for an increasing number of low quality patents, that is, patents that have a low inventive step, overly broad claims, or that should not have been issued under existing legal frameworks. If so, it is desirable to explore whether this is reflected in indicators of individual patent value. In this paper we look at how a firm’s stock of patents and different indicators of its ‘quality’ are priced by the financial markets. We use a number of indicators of technical and economic value: forward citations adjusted for citation truncation, technological scope, measured by the number of technological fields, and family size (the number of different patent systems in which protection for a single invention is sought).

2 Another motivation of this paper arises from the differences between the US and the European patent systems. Unlike the US system, the European system is very fragmented.

Applicants to the EPO systems have to specify the EU countries where the inventions should be protected. If granted, the patent must be defended in national courts because there is at present no European-wide court dealing with patent litigation. The same patented invention then may yield varying private values to its owner depending on the enforcement power offered by the national courts in which the invention is protected. Recently the European Commission (EC) has proposed a new treaty, the European Patent Litigation Agreement (EPLA) that would establish a new European Patent Court. It is unclear whether such a move would represent a significant step towards a “community-wide” patent. However, the proposal testifies to the great concern of the EC about the costs of patenting in Europe and the application of uniform standards in patent examination and enforcement.

In theory the absence of a centralized European patent system, which increases both the application and enforcement costs of EPO patents as compared with US patents, should discourage patent applications to the EPO. However, the EPO examination system appears to be more rigorous than the USPTO (see, for example, Quillen et al. 2002) and this should reduce the expected post-grant litigation costs, especially given the availability of the lower cost opposition system for challenges to newly-issued patents. On the other hand, until the year 2000, patent applications to the USPTO were not published until (and if) they were granted. New applicants then could not know whether their patents were infringing a pending patent. After the year 2000, the US system adopted a variation of the EPO system rule and patent applications are now published after 18 months unless the applicant has sworn not to file in any other jurisdiction.

Other differences between the two patent systems pertain to citation of prior art and patentable subject matters. These differences may affect the economic value of patents in the two systems.

This paper looks carefully at the implications of these differences for the economic value of patents by comparing the market value of patents granted by the USPTO and by the EPO.

Some European firms protect their inventions in both patent systems and some rely on only one patent system. The choice to protect in one or the other system or in both systems can result from at least two sources: patents on more valuable inventions may be taken out in more jurisdictions (Lanjouw et al. 1998) and firms may differ in their patenting strategies or exposure to international competition. Although we cannot distinguish these two hypotheses precisely in the absence of an appropriate instrument for the choice, we are able to determine whether patents 3 from different jurisdictions yield significantly different consequences for the market value of the firm, or indeed whether measures based on the different patents from the two different systems have different predictive power.

In the last part of the paper, we focus on a specific technological field, software, so that we can distinguish the differences between the two systems from other factors specific to the patent system. Software is of particular interest because it is treated differently in the EPO and the USPTO. A few key decisions taken by the Courts of Appeals for the Federal Circuit (CAFC) in 1994-1995 led the USPTO to release new guidelines for software patentability in 1996 which allowed the patenting of any software embodied in physical media. In 1998 an important decision of the US Federal Circuit removed most of the exceptions to the patentability of software ‘as such’, i.e., independently of its links with a physical device. Not surprisingly, the number of software patents granted by the USPTO has increased dramatically during the 1990s.

The treatment of software in the EPO is different. According to the European Patent Convention (EPC) (Art 52) computer programs “as such” are excluded from the patentable subject-matter. The EPO recognizes the patentability of computer-implemented inventions (CII), that is “inventions whose implementation involves the use of a computer, computer network or other programmable apparatus, the invention having one or more features which are realized wholly or partly by means of a computer program” (EPO, 2005:3). A further test applied by the EPO relates to the subject matter of any CII, effectively excluding those related to business methods or otherwise “nontechnical” in nature. This distinction has proved difficult to make in practice, but it does lead to rejection of a number of patent applications whose equivalents are granted at the USPTO. The European Commission released a proposed Directive on the Patentability of CIIs in 2002 which effectively codified EPO practice in this area, but the Directive was rejected by the European Parliament in 2005 after considerable amendment of various kinds.

As a preliminary test of the consequences of the different legal treatment of software in the two patent systems we have analyzed EPO patents and found an increasing number of software-related patents during the 1990s.2 This suggests that, despite the different legal environment, barriers to software patents have fallen somewhat in Europe as well. It is important 2 For a detailed analysis of software-related patent applications and the search methodology used to identify this category of patents, see Thoma and Torrisi (2005) 4 to note, however, that the majority of software patents in the EPO are probably ‘software-related’ patents, that is patents granted to computer programs that are implemented in physical devices, rather than “pure” software patents.3 Our examination of the market value of patents draws on a body of studies which have addressed the issue of measuring the private returns or value of innovation investments using data on the firm’s valuation in public financial markets. Most of these studies use R&D expenditures and patent counts as measures of technological activity (e.g., Griliches 1981; Hall 1993). More sophisticated indicators of technological assets such as citation-weighted patents have also been experimented with in the literature to account for the great dispersion in the value distribution of patents (Hall, Jaffe, and Trajtenberg 2005). In the absence of more direct measures of the economic value of patents, these studies provide a useful methodological setting to explore the relationship between technological importance and the profitability of patented inventions. These studies have mostly used data for US firms and UK firms.

Research that compared indicators of individual patent value such as citations with survey-based direct measures of profits from the associated invention has found a positive and significant association between them (Harhoff et al. 1999). More recently, Gambardella et al.

(2005) have adopted the same approach as Harhoff et al., but using a new survey of European inventors and found similar results. However, to our knowledge, there are only few studies focusing on European firms which analyze the economic value of R&D or patents using firm market value and most of these are for the UK only: Blundell et al. (1995), Toivanen et al.

(2002), Bloom and Van Reenen (2002), and Greenhalgh and Rogers (2006). The only exception is Hall and Oriani (2006), who look at the market value of R&D (but not of patents) for three continental European countries: France, Germany, and Italy.

Several of these market valuation studies rely on measures of R&D expenditure, which is usually considered a measure of innovation input rather than innovation output or ‘success’ of innovative activities. However, in the case of European firms, data on R&D expenditures are often missing because reporting these expenditures is not required by accounting and fiscal regulations across most European countries. The UK is probably the only European country where an explicit recommendation of accounting practice encourages firms to disclose their 3 This assertion has been confirmed by Bergstra and Klint (2007), who looked closely at 32 of the patents defined as software using the union of the two methods described later in the paper and concluded that only two were “pure” software.

5 R&D expenditures.4 Nevertheless in this paper we rely on a sample of European firms for which R&D data is available, covering about 70 per cent of European business sector R&D in the year 2000, and then augment this panel with patent data. Patents as a measure of innovation have their own drawbacks but, as Griliches (1990: 1661) has remarked, ‘in this desert of data, patent statistics loom up as a mirage of wonderful plenitude and objectivity.’ The paper is organized as follows. The next section describes the method for estimating the private value of R&D and patents using financial data. Section 3 presents the data and describes the main variables while Section 4 reports the main results. Section 5 discusses the results and closes the paper.

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