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Discussion Paper No. 13-015

The Effect of

Patent Litigation on Firm Performance –

Evidence for Germany

Paula Schliessler

Discussion Paper No. 13-015

The Effect of

Patent Litigation on Firm Performance –

Evidence for Germany

Paula Schliessler

Download this ZEW Discussion Paper from our ftp server:

http://ftp.zew.de/pub/zew-docs/dp/dp13015 .pdf

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Discussion Papers are intended to make results of ZEW research promptly available to other economists in order to encourage discussion and suggestions for revisions. The authors are solely responsible for the contents which do not necessarily represent the opinion of the ZEW.

Non-technical Summary While the benefits of patents for society as well as for patentees have extensively been studied in the theoretical and empirical economics of innovation literature, researchers in recent years have more and more concentrated on potential negative effects of patents. These negative effects can arise if the estimated costs of the patent system to an innovator exceed the estimated benefits (Bessen and Meurer 2008). This can for example be the case if the costs of defending a patent right exceed the profits of owning it. If there is a negative impact of patent litigation for patentees or inadvertent infringers an ex-post tax is imposed on the innovative effort which results in an ex-ante reduction of innovation incentives (Bessen Meurer 2008).

Against this background the contribution at hand considers the costs and benefits of patents by analyzing how patent litigation affects the firm value of the disputing firms.

Making use of the fact that patents involved in patent infringement litigation constitute highly valuable intangible assets I expect decisions about the infringement of these highly valuable patents to be reflected in the value of the firms involved in litigation.

This paper has two main objectives. The first objective is to model, in a stylized way, the impact of patent litigation and its outcome on the firm value of the plaintiff and the defendant, taking into account the particularities of the German patent litigation system. The second objective is to empirically test the hypotheses derived from this stylized model by using changes in credit rating for German firms as a proxy for changes in firm value.

I find evidence that patent litigation is indeed reflected by changes in the firm value of plaintiffs and defendants. Defendants are negatively affected by a loss in trial or a settlement deal, while a victory leaves their firm value unchanged. I further show that small and inexperienced defendants are at a disadvantage compared to larger and more experienced firms, indicating that they are affected more severely by business disruption and financial distress. By contrast I find a positive treatment effect of litigation on the plaintiffs, independent of the outcome of the case. The results match theoretical considerations on the functioning of the bifurcated patent litigation system in Germany: The temporal separation of decisions on patent infringement claims and corresponding patent invalidity (counter) claims provides a strategic advantage to the plaintiff. The delayed decision of invalidity counterclaims (temporarily) shifts a large share of the bargaining power to the plaintiffs as they have little to lose from the infringement trial. This may lead to defendants being forced into unfavorable settlement agreements.

Das Wichtigste in Kürze Während der private und gesellschaftliche Nutzen von Patenten in der theoretischen und empirischen Innovationsökonomik bereits ausgiebig erforscht wurde, mehren sich in den letzten Jahren zunehmend Studien, die potentielle negative Effekte von Patenten aufgreifen. Diese entstehen, wenn die für einen Innovator durch das Patentsystem entstehenden Kosten den Nutzen übersteigen (Bessen und Meurer 2008).

Wenn zum Beispiel Patentstreitigkeiten einen rechtmäßigen Patentinhaber oder einen versehentlichen Verletzer eines Patentes schädigen, gleicht dies einer ex-post Steuer auf den Innovationsaufwand und führt zu einer ex-ante Reduktion von Innovationsanreizen (Bessen und Meurer 2008).

Vor diesem Hintergrund untersucht diese Studie wie Patentverletzungsverfahren den Firmenwert des Klägers (Patentinhabers) und des Beklagten beeinflussen. Aufgrund der Tatsache, dass in Patentprozesse involvierte Patente besonders wertvoll sind, erwarte ich, dass sich Entscheidungen über die Verletzung dieser Patente im Firmenwert widerspiegeln.

Diese Studie hat zwei Ziele. Zum einen wird der Einfluss von Patentverletzungsprozessen und deren Ausgang auf Kläger und Beklagten in einem stilisierten Modell dargestellt. Hier wird insbesondere auf die Eigenheiten des deutschen Rechtssystems eingegangen. In einem zweiten Schritt werden die aus dem Modell abgeleiteten Hypothesen empirisch getestet, indem Veränderung im Bonitätsindex einer Firma als Indikator für Veränderungen im Firmenwert genutzt werden.

Die Ergebnisse zeigen, dass sich Patentverletzungsprozesse tatsächlich im Firmenwert widerspiegeln. Für die Beklagten ist der Einfluss negativ, wenn sie verlieren oder einem Vergleich zustimmen, während sich bei einem Sieg keine Veränderung zeigt.





Des Weiteren wird deutlich, dass kleine und unerfahrene Beklagte im Vergleich zu großen und erfahreneren Firmen im Nachteil sind, sobald sie in einen Prozess involviert werden. Dies deutet darauf hin, dass sie stärker von durch Unsicherheit ausgelösten wirtschaftlichen und finanziellen Schwierigkeiten betroffen sind.

Im Gegensatz dazu zeigt sich ein durchgängig positiver Effekt von Verletzungsverfahren auf den Kläger (Patentinhaber), unabhängig vom Prozessausgang.

Die Ergebnisse stimmen mit den theoretischen Überlegungen zur Praxis des deutschen Patentverletzungssystems überein. Die zeitliche und örtliche Trennung von Patentverletzungsklagen und den zugehörigen, als Verteidigung der Beklagten genutzten, Patentnichtigkeitsklagen, bringt dem Patentinhaber einen strategischen Vorteil. Da Nichtigkeitsklagen meist erst nach dem Urteil zur Patentverletzung entschieden werden, liegt ein Großteil der Verhandlungsmacht beim Kläger, der nur indirekt vom Verlust seines Patents bedroht ist. Dies erhöht seinen Verhandlungsspielraum im Patentverletzungsprozess und ermöglicht einen vorteilhaften Vergleich.

.

The Eect of Patent Litigation on Firm Performance - Evidence for Germany

–  –  –

Abstract I analyse how patent litigation outcome in Germany aects the performance of the disputing rms by interpreting changes in a rm's credit rating as a proxy for changes in rm performance. The results match theoretical considerations on the functioning of the bifurcated German patent litigation system: The separation of litigation and invalidity decisions, resulting in invalidity decisions taking much longer than decisions on infringement, provides patent holders with a window of opportunity to enforce patents that may later be invalidated. This shifts a major share of the immediate risk to the defendant and allocates bargaining power to the plainti. The estimation results provide support for this incongruity. Plaintis on average prot from litigation while defendants agreeing upon a settlement deal lose as much as defendants losing in trial. I further show that small, inexperienced defendant rms are at a disadvantage when dealing with litigation.

Key words: Patent, Patent Litigation, Credit Rating, Firm ValueJEL: O34, K41

I am grateful for the funding of this research project by the Centre for European Economic Research (ZEW) within the Research program "Strengthening Efciency and Competitiveness in the European Knowledge Economies" (SEEK) and by the Thyssen Foundation. I thank Dirk Czarnitzki, Antonio Della Malva, Reinhilde Veugelers, Daniel Höwer, Katrin Cremers, Bart Leten, Jörg Claussen, Bettina Peters for helpful comments.

1 Introduction

The benets of patents for society as well as for patentees have extensively been studied in the theoretical and empirical economics of innovation literature (Nordhaus 1962, Jae and Traitenberg 2002, Scotchmer 2004). Private benets arise from innovation returns to the patented technology that exceed the patent's R&D costs. These materialize through an increased market share, a price premium for high quality products, the reduction of production costs or from licensing revenues (Greenhalgh and Rogers 2007). Many contributions have shown that patents and patent quality as measured by forward citations in general have a positive eect on rm value that goes beyond the R&D expenditures of the rm (Hall 2000, Hall, Jae and Trajtenberg 2005, Czarnitzki and Kraft 2004).

In recent years however, with the increased focus on the notion of probabilistic patents (Lemley and Shapiro 2005), researchers have more and more stressed potential negative eects of patents. These negative eects can arise if the estimated costs of the patent system to an innovator exceed the estimated benets (Bessen and Meurer 2008a). This is the case if the prot an innovating rm receives from owning its own patents is smaller than the cost it has to incur to hold o allegations of patent infringement (Collins 2009, p.1). These costs may for example be related to the validity decision of the patent. Farrell and Shapiro (2008) demonstrate that in case of uncertain property rights determining patent validity prior to licensing (as a measure to avoid litigation) is socially benecial as weak patents can still yield high licensing royalties because "challenging the patent is a public good for the downstream rms" (Farrell and Shapiro 2008, p. 1362). And Shapiro (2010) shows that for weak patents, covering a minor feature of a high-margin product that takes time to redesign, a large fraction of royalties negotiated during patent litigation can be attributable to hold-up and not to the value of the patented technology as such.

If there is a negative impact of patent litigation for patentees or inadvertent infringers an ex-post tax is imposed on the innovation (Bessen and Meurer 2008b, p. 3) which can result in an ex-ante reduction of innovation incentives (Bessen and Meurer 2008b, p.26).

Against this background the contribution at hand considers the costs and benets of patents by analysing how patent litigation aects the performance of the disputing rms. Making use of the fact that patents involved in patent infringement litigation are generally located the very top of the patent value distribution (Lanjouw Schankermann 2001, 2004, Cremers 2004) and thus constitute highly valuable intangible assets I expect decisions about the infringement of these highly valuable patents to be reected in the performance of the rms involved in litigation.

This paper has two main objectives. The rst objective is to model, in a stylized way, the impact of patent litigation and its outcome on the rm value of the plainti and the defendant, taking into account the particularities of the German patent litigation system. The second objective is to empirically test the hypotheses derived from this stylized model by using changes in credit rating for German rms as a proxy for changes in rm performance. A conditional dierence-in-dierence approach can be applied to evaluate the eect of patent litigation on the performance of both plainti and defendant, which is then analyzed with respect to dierences between trial outcome, trial-specic characteristics as well as rm characteristics.

I nd evidence that defendants are negatively aected by a loss in trial or a settlement deal, while a victory leaves their rating unchanged. I further show that small and inexperienced defendants are at a disadvantage compared to larger and more experienced rms, indicating that they are aected more severely by business disruption and nancial distress. By contrast I nd a positive treatment eect of litigation on the plaintis, independent of the outcome of the case. The results match theoretical considerations on the functioning of the bifurcated patent litigation system in Germany: The temporal separation of decisions on patent infringement claims and corresponding patent invalidity (counter) claims provides a strategic advantage to the plainti. The delayed decision of invalidity counterclaims (temporarily) shifts a large share of the bargaining power to the plaintis as they have little to lose from the infringement trial. This may lead to defendants being forced into unfavorable settlement agreements.

This paper builds on the existing literature on the impact of litigation on rm value, but to my knowledge is the rst to disentagle the eect with respect to the dierent trial outcomes and the rst to consider the particularities of the German system.

The remainder of this paper is organized as follows: Section 2 summarizes existing studies on the eect of litigation on rm value. Section 3 presents a stylized model of the eect of litigation on plaintis and defendants. I derive several hypotheses on the impact of litigation on rm performance. Section 4 contains the empirical analysis, starting with an argument for credit rating as a measure for rm performance, followed by the the estimation approach, a data description and the descriptive analysis. I then present the matching procedure and terminate with the estimation results and some robustness checks.

Section 5 summarizes the main ndings and concludes.

2 Previous Empirical Literature

Most empirical contributions focusing on the private costs of patent litigation make use of stock market data and apply event study methods. The basic concept of the event study methodology in the context of patent infringement suits is that new information contained in the beginning or termination of patent infringement litigation leads the market to update its expectations about future prots and to accordingly adjust the stock market value of the rm. Abnormal stock returns are then attributed to the litigation eect and used to quantify the eect of litigation on the market value of the rm.



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