Does going public affect innovation?

From Shai Bernstein, on the job market from Harvard:

Abstract: This paper investigates the effects of going public on innovation. Using a novel data set consisting of innovative firms that filed for an initial public offering (IPO), I compare the long-run innovation of firms that completed their filing and went public with that of firms that withdrew their filing and remained private. I use NASDAQ fluctuations during the book-building period as a source of exogenous variation that affects IPO completion but is unlikely to affect long-run innovation. Using this instrumental variables strategy, I find that going public leads to a 50 percent decline in innovation novelty relative to firms that remained private, measured by standard patent-based metrics. The decline in innovation is driven by both an exodus of skilled inventors and a decline in productivity among remaining inventors. However, access to public equity markets allows firms to partially offset the decline in internally generated innovation by attracting new human capital and purchasing externally generated innovations through mergers and acquisitions. I find suggestive evidence that changes in firm governance and managerial incentives play an important role in explaining the results.


This doesn't surprise me at all- similar types of public choice issues seem to arise in public companies just as they arise in government.

Patents primarily serve to bamboozle private equity investors.

There may be a standard of patent based metrics for lazy economists, but patent economists and engineers have a different near-universal conclusion about patents. Outside the chemical and pharmaceutical industries, patents have no relation to innovation or innovative thinking and drain the morale and energy of your engineers. Overwhelming majorities of patents have no bearing on useful products and solid majorities don't describe a real, specific engineering process at all but are jumbles of patent-lawyer cant and boilerplate.

Private equity investors claim to like to see that a company has a patent portfolio. Public company investors like to see profits or market share increases. That's why private companies file more patents, ceteris paribus.

Of course, a patent portfolio is important in litigation, but the strict number and specific subjects are irrelevant. The problem is simply to have enough plausible ones to reach a settlement. A panel of twelve Texans who couldn't get out of jury duty is never going to consider actual technical claims anyway if it gets to trial. The PTO is only marginally more competent than the subnormal Texans lately.

A good framework to think about patents is a minefield. Patents are like a landmine. Very few patents are filed because an employee discovered some novel process or device. Their main goal is to trip competitors who might in future have some ace up their sleeve.

Let's say we can't find a better way to drill for deep sea oil ; even so we patent a lot of smaller related art (that we have no intention of putting into use). That's a great way to hinder a rival that does have an innovation; and even better if we can extort licensing fees out of them.

I don't know about other industrys, but here in biotech patents sure are useful, and valuable, altho the 80/20 rule is more like 5/95 - 5% of the patents are 95% of the value (or even 1/99)

I would think that economists would ask the question, why do investors see value in patents, if the people writing the patents don't.
What would a competitive market analysis say about the investors - they are mostly stupid ?

One also has to question why managment continues to spend large sums on a useless activity. Patents are, aside from internal costs, 20 grand and up (rapidly) esp if you have a lot of national phase filings. 100 patents a year, thats a lot of money.

One has to note (for rahul, below) that there is a cheaper way to do this: technical disclosure. IBM use to publish JTID, the journal of technical information disclosures. The idea was that if you didn't want to go to the effort of filing, you would publish a paper with your information and ideas; this constituted a public disclosure, which meant the info and ideas couldn't be patented by your opponent.

I think your claims about the jury are slighlty off; in the markham hearing for instance, a lot happens, and after the jury, as I'm sure you know, patent appeals go to the special court, where people are at least awake.

Warren Buffett says the ideal business can leverage large amounts of capital at high rates of return. This is the opposite, or the subsequent step of the innovation phase. Graduate students are paid roughly zero to produce things noone cares about for a reason. So, no cynical explanations are necessary, because this observation could be things working as they should.

So, becoming less innovative causes IPOs?

Completely agree with Newt here: When we started looking at getting private investors at my company, all of a sudden we started filing nonsense patents. The investors valued patents, so we filed them, despite their being pretty much worthless to us. As soon as the talks died down, we stopped wasting our time on patent filings and got back to innovating.

Did he adjust for the product cycle? It seems more likely that innovation happens more in pre-IPO companies because you IPO only after you have a successful product.

@TallDave, here's a section from the paper's the decline innovation is measured...that seems in line with you concern:

"Using this instrumental variables approach, I find that going public caused a substantial decline of approximately 50 percent in innovation novelty as measured by patent citations. At the same time, I find no change in the scale of innovation, as measured by the number of patents. These results suggest that the transition to public equity markets leads firms to reposition their R&D investments toward more conventional projects."

Seems like this could simply be rephrased in a "low hanging fruit" argument and that many of thee firms are taken public once they *have* a marketable idea, not when one is just on the horizon. Still this looks like a serious, thought provoking paper...job market season is fun.

back in teh real world, where economists rarely venture
What is the diff between small, growing firms, and companies that are public ?
Well, one diff is cash flow and profitiability - generally, small preIPO companies are non profitable, consuming cash at huge rate etc
A small number of these companies manage, despite huge barriers, to become profitable and do an ipo
So why on earth should the two sets (pre ipo, postipo) be the same ?
Isn't this survivorship bias ?

it is a lot easier to buy a small company with new products then do ityourself; innovation is hard and risky, that is why biotech is not more innovative then big pharma; big pharma deliberately lets biotech take the huge risk of innovation, and then BP uses its cash flow to bid for the successfull ones

And in news from the real world, small private companies innovate. When they have a solid, marketable product, they have an IPO to raise cash to spend on building production facilities, marketing programs, sales channels, maintenance programs etc.

By definition, early stage companies are more "traditionally" innovative than large, mature companies. Innovation in large mature companies relates to ways to make the gadgets cheaper, better, faster to market etc.

Measuring innovation by patents is a bad idea, especially in software industry.

In software industry, 95%+ patents are nonsenses that wouldn't stand up to any scrutiny, and are only used as tools of defense against competitors. The Patent Office is absolutely unqualified to weed out nonsense, and, as a result, things like "blinking cursor" can and do get patented (40 years after the first use) routinely.

It seems that *real* innovation in software slowed down significantly after adoption of software patents in the USA.

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