Can Piracy Increase Innovation? Software Firms' Responses to Online File Sharing

Abstract

Existing theory predicts two possible and opposing competitive responses by firms to digital
piracy, resulting in an ambiguous impact on innovation. We resolve this tension by using a natural
experiment stemming from a shock to file-sharing technology, which led to a sudden increase in
piracy in the early 2000's, to analyze the impact of piracy on innovation in the software industry.
Using difference-in-differences and instrumental-variables estimators to compare a treatment
group of consumer-focused software firms with a matched control group of enterprise-focused
software firms, we find that piracy led to an increase in subsequent R&D spending, copyrights,
trademarks, and patents for large, incumbent firms. However, we find that firms decreased their
rate of new product releases following the rise in piracy. We conclude that piracy pushes firms to
develop new products that are superior to those available as pirated substitutes, but this innovation
may reach the public at a slower pace. Our findings have implications for managers pursuing value
appropriation in knowledge-based industries while faced with the threat of digital piracy.

Keywords: piracy, software, innovation, intellectual property

JEL Classification: O32, O33, O34, D23