The Marketplace of Ideas: Information About Innovation Boosts Patent Trading

Nearly 389,000 U.S. patents were granted in 2020, or more than 1,000 per day on average. The list of new inventions encompassed everything from technologies that connect driverless cars with 5G networks to robotic grasping software to machine learning algorithms designed to write persuasively human narratives.

The invention market is, in short, a firehose of ideas — some brilliant, many duds — and it draws billions of dollars of investments hunting for profitable novelty. Thirty percent of patents granted from 1994 to 2017 were sold at least once by 2020.

And yet, according to Jinhwan Kim, an assistant professor of accounting at Stanford Graduate School of Business, this secondary market for patents is frequently overlooked when considering the process of innovation. “Most of the research on innovation examines how something new gets produced,” not how the idea itself moves about. “But a lot of patents are sold and resold every year,” Kim says. “One company may develop an idea while another company purchases and commercializes it.”

Hoping to shed more light on this important market, Kim, who studies the economic effects of information disclosure, looked at the relationship between decades of corporate filings and the efficiency of the patent market, which is deeply fractured and suffers from a lack of transparency. In research conducted with Kristen Valentine of the University of Georgia, he found that 10-Ks containing discussion about innovation or R&D appear to support the patent market by sending out signals related to price and risk.

Movers of Invention

Kim and Valentine organized publicly traded companies into groups based on their use of similar technologies. Within each “tech class,” they looked at how often annual reports in each year between 1994 and 2017 used phrases related to innovation like “technology breakthrough” or “new patent.” The number of phrases was then linked to the number of patent sales within that same tech class the following year. They found that the more often companies mentioned innovation in their annual reports, the more frequently similar companies traded patents the next year. Tech classes with the most mention of innovation were linked to a 13% increase in future patent sales.

“It’s a spillover story,” Kim says, likening the effect to the real estate market. “Knowing what your neighbor sold their house for is a very useful price signal that tells you what your house might be worth. Similar information is provided in 10-Ks, where you can see how much your competitor or peer sold a patent for, presumably in a related area.” This information can encourage further buying and selling of patents by bringing greater clarity to the market. Annual reports also help illuminate investment risks by showing, for instance, what types of patents appear to be magnets for litigation.

The researchers then pushed these findings slightly further: If 10-K disclosures about innovation do, in fact, help to make the patent market more efficient, then one would expect fewer bad trades to take place in tech classes with high levels of disclosure. “And that’s basically what we find,” Kim says. “When trades take place where there is more disclosure, we also see that those patents are less likely to be resold in the future, which suggests that the initial trade or allocation is more efficient.”

Precisely what kind of information within a 10-K is most helpful remains an open question. Kim and Valentine looked only at the high-level connection between the number of innovation-related phrases in a report and how many trades took place the following year. Future research could investigate which particular dimensions of disclosure are most useful.

Additionally, whether 10-K disclosures are ultimately the best way to streamline the patent market is unclear; there could be policies crafted from the ground up that more effectively connect buyers of patents and sellers.

“But I’m an accounting researcher by training, and so it’s almost as though I have this 10-K-centric view of the world,” Kim says. “One of the justifications for forcing firms to disclose financials is that it creates these externalities that help others. For policymakers, it’s important to think about how far-reaching these influences are.”