Creditor Rights and Innovation: Evidence from Patent Collateral
Patents have attracted controversy over whether they foster or hinder innovation. In his paper, William Mann is one of the few that establish a causal relationship between patents and R&D activity. The study begins by presenting empirical evidence for the pledge of patents as collateral to raise debt financing. Next, by means of robust econometric methods, he documents that patent pledging companies raised more financing, and spent more on R&D, when creditor rights to patents strengthened. Subsequently, these companies exhibited a gradual increase in patenting.
First, the author establishes the quantitative importance of patent collateral: 16% of patents produced by US corporations have been pledged as collateral at some point, and the companies pledging them performed 20% of R&D and patenting in Compustat (a database of financial, statistical and market information on active and inactive global companies) in 2013. To examine a causal link between patents and R&D intensity, he exploits a natural experiment. Creditor rights are not randomly assigned across borrowers, but arise endogenously from their legal and economic environment. However, four court decisions have clarified the legal status of patents nationwide. These decisions, from 2002, 2003, 2007, and 2009, expanded the importance of state law over federal law for governing transactions involving patents. Some states provide stronger creditor rights than others, most notably Delaware. For firms incorporated in Delaware, the court decisions thus represented a relative strengthening of creditor rights – only to patents, isolating their collateral value.
The experiment signals the effect of strengthening creditor rights in leading to increased borrowing by treated firms (i.e., firms incorporated in Delaware). Compared to non – treated firms (i.e., firms outside Delaware), their average total debt rose by $1 for every $100 of total (book) assets in the two years on average following a court decision. According to the author, stronger creditor rights primarily, and significantly, increased access to finance for innovative firms, as lenders evidently became more optimistic about the probability and speed of recovering patent collateral in default.
Mann further shows that this increased borrowing translated into increased investment in innovation, as measured by the firm’s R&D spending. Treated firms’ quarterly R&D spending rose by $0.17 for every $100 of total assets on average following a court decision. The R&D effect represents a 6.3% increase relative to pre-court decisions average quarterly R&D-to-assets ratio. This finding demonstrates that increasing the collateral value of intangible assets alleviated credit constraints for investment in R&D.
Finally, the financing effect is absent for companies that had not yet produced patents, but is particularly strong for those that have previously pledged their patents as collateral, or that own patents that receive many citations.