Profiting from Technological Innovation: The Effect of Competitor Patenting on Firm Value

Abstract

In 1986, Teece proposed a seminal framework for analyzing why innovators may fail to benefit from their innovations. He argued, in part, that firms with the requisite complementary assets can often expropriate an innovator's returns especially when appropriability regimes are weak. In this paper, we explore the implications of this framework from the perspective of an incumbent firm - more precisely, of investors in that firm - facing innovation by inventors from outside its industry. We demonstrate that the financial-market value of publicly traded firms depends on patented innovation by competitors, both existing rivals and industry outsiders. Our empirical study generates three main results. First, the financial-market value of an incumbent is negatively associated with "important" patenting by outsiders. Second, in industries characterized by weak appropriability regimes or by a strong reliance on complementary assets, this relationship is reversed: important patenting by outsiders is positively associated with the incumbent's financial-market value. Third, the effect of outsiders' patented innovation on the focal incumbent is qualitatively different than that of existing rivals' patented innovation on the incumbent. These results are consistent with implications of Teece (1986) and with recently developed models that formalize elements of his framework. More generally, these results support theories about both the market-stealing and spillover effects of innovation.

Keywords: innovation, market value, complementary assets, appropriability regime, incumbent, entrant

JEL Classification: O32, O31, L10