Original intellectual property (IP) and corporate research and development (R&D) are both related to the broader idea of innovation. Companies research and develop with the objective of increasing a consumer’s willingness to pay for products, and reducing the cost incurred by the firm to produce and deliver the product. The study of IP includes outputs of R&D processes such as patents and inventions, as well as other creations such as literary and art works, designs, symbols and names and how firms use these rights strategically.
Corporate R&D and Intellectual Property (IP) have been both extensively studied with several hundred published journal articles on these topics.(Caballero and Jaffe 2002) Both are related to the broader idea of innovation, which is the creation of novel products and processes. (Caballero and Jaffe 2002) Broadly, business firms perform R&D with two possible objectives: increase the consumers' willingness to pay for their products (by improving their current products or introducing new products) and reduce the cost incurred by the firm to produce and deliver the product. Most of the $330 billion in reported annual R&D by US firms occurs in manufacturing, information, and software industries (NSF, 2013). In addition to business firms, universities and government institutions perform significant R&D.
IP includes outputs of the R&D process such as patents and inventions as well as other creations such as literary and art works, designs, symbols and names. Of these, patents and new product inventions have been the most widely studied, and will be the main focus of this note.
Returns to R&D
Many academic studies have established robust positive correlations between R&D investments and productivity growth at the country-level, and corporate R&D is one of the most important sources of economic (productivity) growth (Griffith, Redding and Van Reenen, 2004) and a key source of sustained competitive advantage for business firms. There is a clear positive relationship between R&D investments and firm profitability, (Lichtenberg 1992) and though estimates vary widely, the median rate of return to privately-funded R&D has been estimated to be over 25%. (Fraumeni and Okubo 2005) (Hall and Mohnen 2009) R&D investment increases with firm size though smaller and younger firms tend to have more patents per dollar of R&D.
R&D investments also benefit those who do not invest, but can access the new knowledge freely through "knowledge spillovers". (Romer 1990) (Grossman 1991) Over the years, evidence has accumulated in favor of significant 'spillovers' of R&D. (Griliches 1992) In line with this, social returns to R&D are often estimated to be significantly higher than private returns. (Fraumeni and Okubo 2005) (Hall and Mohnen 2009)
Patents are important economic indicators (Griliches 1990) (Hall, Jaffe and Trajtenberg 2005) (Balasubramanian and Sivadasan) and are generally correlated with better firm performance such as market value, firm size, IPO success and survival. They signal quality (Hsu and Ziedonis 2008) and enable markets for technology.
Intellectual Property Rights
In theory, strong intellectual property rights (IPR) spur R&D investments and innovation by allowing the owners to control the fruits of their investments. Common IPRs include patents, trademarks, registered designs, and copyrights. However, firms can, and do, choose among several other mechanisms, such as lead-time, secrecy, or bundling with complementary services, to control and appropriate the returns from their R&D. (Levin, Klevorick, Nelson and Winter, 1987) (Cohen, Nelson and Walsh 2000) In fact, surveys of managers indicate that only a small fraction of the corporations that innovate seek IPRs, and a majority relies on alternative mechanisms to profit from their inventions. (Hall, Helmers, Rogers, and Sena 2014)
Some scholars have also noted that IPRs, such as patents, may discourage innovation by imposing large costs on inventors seeking to build on patented knowledge. (Heller and Eisenberg 1998) These large costs may even be relevant for reduced firm entry, as a few recent studies in the software industry have found that patents may deter new firms from entering the market. Hence, the link between IPRs and innovation is a subject of some debate. We also do not know much about how inventors choose among different appropriability mechanisms, or the effect of the choices on profitability and follow-on innovation. Finally, we know little about how the unique challenges faced by different industries (e.g., pharmaceuticals versus electronics) and countries (e.g., developed versus developing) affect the link between IPR and innovation. These questions are important for public policy.
Areas for Additional Research
Though there are many aspects of R&D and IP that require additional research, the internal organization of innovative activities in young firms is perhaps the most opaque aspect. We know that young firms tend to be more innovative but questions such as how they choose R&D projects, how they finance them, how they manage them, how they motivate inventors still require detailed answers.
Given the breadth of these topics, there have been several detailed literature reviews acrossdisciplines on individual subtopics (e.g., measuring the returns to R&D in Hall, Mairesse and Mohnen; (2009) financing of R&D in Hall; (2002) economics of patents in Hall and Harhoff; (2012) role of public vs. private R&D in David, Hall and Toole; (2000) university to industry knowledge transfer in Agrawal (2001)). Hence, I do not make an attempt to provide a general summary of the field. Instead, I discuss issues that are broadly relevant to small and young firms.
Among the oldest studies on corporate R&D are those that examine if R&D investments among firms vary by their size. Schumpeter (1942) argued for the advantage of large firm size in R&D investments. Several studies since then have found that large firms are not only more likely to report R&D but also invest more in R&D. However, it is not clear if they account for a disproportionately larger share of R&D investments (e.g., Bound et al 1984; Cohen, Levin and Mowery; Veugelers) (Cohen, Levin and Mowery 1987) (Veugelers 1997) relative to their output. It is generally agreed that larger firms tend to generate fewer innovations per unit of R&D (Bound et al 1984; Pavitt et al 1987). (Acs and Audretsch 1998) (Acs and Audretsch 1991) However, this does not imply they are less innovative. As Cohen and Klepper (1996) point out, larger firms can spread the benefits of an innovation over more units of output, thus making it feasible for them to undertake marginal projects that would not be undertaken by smaller firms. In a follow-up paper, Cohen and Klepper (1996) argue and find supporting evidence that this would also imply that larger firms are more likely to undertake process R&D.
Direct evidence on whether firm age affects the magnitude of R&D investments is very scarce. However, a few studies have examined innovation and firm age. Hansen (1992) finds that innovation and firm age are inversely related while Agarwal (1998) relates survival of small firms to their innovative performance. More recently, Huergo and Jaumandreu (2004) find a non-linear relationship between the probability of introducing a process or product innovation with youngest and oldest firms exhibiting higher probabilities of doing so. Using patent data, Sorensen and Stuart (2000) find that firm age is negatively related to patent citations. Similarly, Balasubramanian and Lee (2008) find that firm age is negatively related to technical quality with each additional year reducing the impact of a 10% increase in R&D intensity on the firm's market value by over 3%.
Griliches (1992) observed that spillovers of R&D are widely prevalent. Some studies, especially in the context of university-industry knowledge transfers have found that smaller firms appear to benefit more from such spillovers. Acs, Audretsch and Feldman (1994) found that innovation in smaller firms exhibit a greater elasticity to changes in university R&D suggesting that such firms benefit more from university-research based spillovers. Link and Rees (1990) come to the same conclusion with a different dataset though they attribute to the lower degree of reliance on university research among larger firms to their bureaucratic inefficiency. However, Cohen, Nelson and Walsh (2002) and Laursen and Salter (2004) find that larger firms are more likely to use university (or public) research. Evidence on the link between firm age and R&D spillovers is more sparse. Cohen et al (2002) find that start-ups are more likely to use public research but Laursen and Salter (2004) do not find similar evidence.
A number of studies have examined the role of internal capital constraints on the decision to perform R&D. For recent reviews, refer to Hall (2002) and Becker (2013). This is of particular interest due to two distinctive aspects of R&D. First, R&D creates tacit knowledge, a part of which is resident in the minds of the firm's employees, who can leave the firm and choose to take such knowledge with them. Second, the outcomes of R&D investments are highly uncertain. Together, these aspects imply a tendency among firms to underinvest in R&D.
This tendency to underinvest is likely exacerbated in the presence of capital constraints, a factor often important for young firms. Earlier evidence on the subject was mixed though more recent studies appear to indicate a positive relationship between cash flows and R&D investments, especially for young and innovative firms. Brown, Fazzari and Petersen (2009) estimate dynamic R&D models for high-tech firms and find significant effects of cash flows and equity for young firms but not for mature firms. Brown and Petersen (2011) find evidence that young firms, unlike mature firms, rely extensively on cash holdings to smooth R&D. Czarnitzki and Hottenrott (2011) find that smaller firms "suffer more from external constraints for R&D investment than larger firms" (p. 79). In a slightly different vein, Czarnitzki and Hottenrott (2011) find that expenditure on cutting-edge R&D is adversely affected while expenditure on routine R&D is not. This is consistent with the greater uncertainty associated with cutting-edge R&D. Since younger firms are more likely to enter the market with cutting-edge innovations, this could also potentially explain why they face greater capital constraints with regard to R&D investments. While the presence of venture capital addresses some of the problems associated with financing innovation, it does not appear to completely mitigate them. (Hall 2002)
One approach to address the resource constraints and credibility gap faced by young and small firms is to collaborate and develop networks with partners. In addition to these two functions, networks may also help with discovery of opportunities. (Elfring and Hulsink 2003) Lerner, Shane, and Tsai (2003) find that "in periods characterized by diminished public market financing, small biotechnology firms appear to be more likely to fund R&D through alliances with major corporations rather than with internal funds raised through capital markets". Similarly, Czarnitzki and Hottenrott (2012) find that collaborative research helps reduce liquidity constraints. Such collaboration also acts as quality signals for young firms. Stuart (2000) finds that consistent with status-transfer arguments, young and small firms benefit more from large and innovative strategic alliance partners than do old and large organizations. Similarly, Gulati and Higgins (2003) find that IPO success is affected by the presence of a strategic alliance.
A closely related area of research is "markets for technology", which have become increasingly important, (Arora and Gambardella 2010) and includes patent and technology licensing, joint ventures and technology acquisitions. From the perspective of entrepreneurs, these markets provide opportunities that would not otherwise exist. For instance, they could choose to be "technology specialists" focusing on technology development alone, and leaving the remaining parts of the value chain to other participants. (Arora, Fosfuri and Gambardella 2001) Put differently, they could profit from the market for ideas instead of profiting from the market for products. (Gans and Stern, 2003)
The bulk of academic research on Intellectual Property Rights (IPR), especially empirical research, has focused on patents. A patent gives its holder the legal right to exclude others from making, using, offering for sale, or selling the invention for a limited duration (twenty years from application date in the US). In return for this exclusive right, the inventor agrees to disclose the invention, such that future inventors can learn from, and build on, the invention.
Patents are used by young and small firms for several reasons. The most obvious reason is to protect their intellectual property and as a source of competitive advantage (Graham et al 2010). This may be particularly critical since their access to other resources is limited. Patents also act as quality signals to external stakeholders such as venture capital investors (Haeussler et al, 2009) (Mann and Sager 2007) (12) (Hsu and Ziedonis 2014) and appear to be associated with enhanced growth (Helmers and Rogers 2011) and survival. (Wagner and Cockburn 2010) Additionally, there is some evidence that patents are effective in ensuring appropriability, especially in the pharmaceutical and chemical industries. (Hall, Helmers, Rogers and Sena 2014)
Graham et al, (2010) provides the most systematic review to-date of patenting behavior among start-ups. In other interesting survey-based studies, Jung and Graham (2010) and Rassenfosse (2012) examine patenting behavior in small firms. The former finds that small firms use patents more to commercialize an invention, to obtain licensing income and to enhance their reputation. In contrast, large firms engage in patenting more for strategic purposes and cross-licensing. The latter study finds that small-and-medium-sized enterprises (SMEs) exhibit a much stronger reliance on 'monetary patents' than large companies. Nearly half of the SMEs in the sample patent for monetary reasons, SMEs tend to use their patents more actively than large firms, and smaller companies generally have a higher proportion of their portfolio that is licensed.
Scholars have also argued that strong patents facilitate the division of labor in the market for ideas, by enabling specialist inventors to sell their early-stage inventions, protected by patents, to downstream firms that specialize in commercialization. (Lamoreaux and Sokoloff 2003) To this point, Gans, Hsu and Stern (2008) also provide evidence that the hazard of technology licensing goes up after patent grant, suggesting that patents facilitate transactions in the market for ideas. Moser (2005) provides evidence that patents also influence the direction of innovation. Using a dataset of nearly fifteen thousand innovations from nineteenth century exhibitions, Moser's research shows that inventors in countries without patent laws focused on innovating in industries in which patents were less important, while innovation in countries with patent laws was more diversified across industries.
Some recent studies reveal the downside of strong patent protection. A series of legal changes in the US in the 1970s and 1980s, culminating with the establishment of the Court of Appeals of the Federal Circuit (CAFC) in 1984, strengthened patent rights and set off a "patent explosion". (Hall and Ziedonis 2001) The explosion is termed the "patent paradox" since the increase in patenting appears to have not been accompanied by proportionate increases in R&D or productivity.
The CAFC's creation is often linked to the subsequent increase in patent litigation in the US, and the proliferation of "trolls," or "non-practicing entities," that profit by litigating R&D firms for infringing on their patent rights. According to Boldrin and Levin, (2012) the resulting patent "arms race" has imposed a barrier for inventors without patents, and outweighs any potential benefit of patents. Heller and Eisenberg (1998) argue that competing patent rights in biotechnology could stifle innovation and prevent welfare-enhancing products from being commercialized.
More generally, patents have entry-deterring and entry-promoting effects. By definition, a patent is a monopoly grant, and hence should prevent entry by competitors. On the other hand, by clearly defining and assigning property rights, patents enable markets for technology and have entry-promoting effects. (Arora and Gambardella 1994) (Gans and Stern 2003) A few studies have highlighted the problem of 'strategic patenting' where firms patent in order to keep competitors and potential entrants out of the market rather than to commercialize the inventions. Cockburn and Macgravie (2011) study software products and find that an increase in the number of patents relevant to market decreases the rate of entry into that market. In a closely-related paper, Cockburn and Macgravie (2009) found that venture capital funding to start-ups in markets characterized by denser patent thickets were delayed relative to firms elsewhere.
All things considered, Gallini, (1952) Horowitz and Lai, (1996) and Qian (2007) suggest that the relationship between the level of IPR and innovation may be U-shaped, such that innovation is stifled by strengthening IPR above a certain optimal level. Jaffe and Lerner, (2004) and Bessen and Meurer (2009) attribute some of the ills and abuses of the US patent system to lax examination standards at the US patent office and call for a reform of the system.
Hence, there is some evidence that patents may stimulate corporate R&D and innovation, and also reasonable arguments that they may hinder innovation. The overall effect of patents on innovation is not clear, and there appears to be some consensus that the US patent system needs reform. There is very little work on evaluating the benefits and costs of the US patent system relative to other commonly used appropriability mechanisms.
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