Relationship-Specific Investments and Firms’ Boundaries: Evidence from Textual Analysis of Patents

Abstract

The hold-up problem can impair firms’ abilities to make relationship-specific investments through contracts. Ownership changes can mitigate this problem. To evaluate changes in the specificity of human capital investments, we perform textual analyses of patents filed by lead inventors from both acquirer and target firms before and after acquisitions. Inventors whose human capital is highly complementary with the patent portfolios of their acquisition partners are more likely to stay with the combined firm post-deal and subsequently make their investments more specific to the partner’s assets. As ownership of another firm results in increasingly specific investments to that firm’s assets, contracting issues related to relationship-specific investments is likely a motive for acquisitions.

Keywords: Textual Analysis, Patents, Investment Specificity, M&A, Mergers and Acquisitions

JEL Classification: G34, L14, L22