The Effect of Patent Litigation on Firms ' Credit Ratings : Evidence for Germany

State of the Art The benefits of patents for patentees and society have extensively been studied in the theoretical and empirical economics of innovation literature. 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 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 Meuer 2008), if for example, the profit an innovating firm receives from owning its own patents is smaller than the cost it has to incur to hold off allegations of patent infringement (Collins 2009). If there is a negative impact of patent litigation for patentees or inadvertent infringers an ex-post tax is imposed on the innovation which results in an ex-ante reduction of innovation incentives (Bessen Meurer 2008). Research Gap Making use of the fact that patents involved in patent infringement litigation are generally located the very top of the patent value distribution and thus 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. Other than most papers on this topic, using market valuation as measure of the impact of litigation on firm value, the major contribution of this paper is that it addresses all firms rather than only publicly listed firms, that it considers the realized rather than the expected effect of litigation and that it can control for different trial outcomes and characteristics. Theoretical Arguments Taking into account specificities of the German legal system I develop a simple scheme of how plaintiffs and defendants in litigation trials can be affected by the outcome of litigation. Overall the German systems results in the risk for plaintiffs being rather low while rather high for defendants. I further examine how certain trial and firm characteristics can alter these effects. Method and Data Using patent litigation data for German firms 2001-2008 a difference in difference approach is applied to estimate the impact of patent litigation suits on the credit rating of the involved plaintiffs and defendants. Interpreting changes in credit rating as a proxy for changes in firm value as well as a measure for the firm's future ability to access external finance I find evidence that patent litigation is reflected in the firm value of the disputants. The data has been collected manually by going into the archives of the district courts with competence for patent litigation. Firm information including credit rating has been added from the firm database Mannheim Enterprise Panel which processes data provided by Creditreform, Germany? s largest credit rating agency. Patent information has been added from Patstat. Results The results suggest that litigation has a measurable impact on firm value, but that this effect crucially depends on the characteristics of the parties and the outcome of trial. Defendants are negatively affected by a loss in trial or a settlement deal, while a win leaves their firm value unchanged. I further show that small as well as 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. The more important the case for the defendant's overall turnover the more severe the effect of litigation. By contrast I find a positive treatment effect of litigation on the plaintiffs, independent of the outcome of the case. This result matches theoretical considerations revealing that the risk of litigation for plaintiffs is rather small, which results from a spatial and temporal separation of litigation and invalidity decisions. I further find that licensees filing suit against infringers of the licensed patent profit even more from litigation than patentees, indicating that the risk of being involved in an invalidity decision is far less severe for this type of plaintiff.