DP8392 Venture Capital, Patenting, and Usefulness of Innovations

Author(s): Simona Fabrizi, Steffen Lippert, Pehr-Johan Norbäck, Lars Persson
Publication Date: May 2011
Keyword(s): innovation, patent law, patenting intensity, preemptive vs late acquisition strategies, signaling, usefulness requirement, venture capital
JEL(s): C70, D21, D82, G24, L26, M13, O31, O34
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8392

We analyze incentives to develop entrepreneurial ideas for venture capitalists (VCs) and incumbent firms. If VCs are sufficiently better at judging an idea's value and if it is sufficiently more costly to patent low than high value ideas, VCs acquire valuable ideas, develop them beyond the level incumbents would have chosen, and use patents to signal their companies' high value to acquirers prior to exiting. This increases the VC-backed companies' patenting intensity and long-run performance, but also infl ates their acquisition prices, and lowers their acquirers' overall profits. Patent law usefulness clauses would reduce such excessive, signaling-driven investment and patenting intensity.