Financial Statement Information and the Market for Innovation

Abstract

We examine the effect of innovation-relevant financial statement disclosures on the liquidity of the secondary patent market. Relative to equity markets, the secondary patent market is decentralized and rife with information frictions yet provides a potentially important tool to reallocate innovations to the most productive users. Using data on patent transactions, we find that a one standard deviation increase in innovation-related financial statement disclosures – proxied by the number of innovation-related phrases in relevant 10-K filings – is linked to a 32% increase (or 46 more patent sales) in a given technology class-year. These results are consistent with financial statement disclosures generating positive information externalities useful for trading patents in the secondary market. The positive link between financial statement disclosures and future patent sales is stronger where information asymmetry is likely greatest (transactions between public and private firms) and where information uncertainty likely prevails (transactions between private firms) relative to transactions less likely to suffer from informational frictions (transactions between public firms). Moreover, consistent with the notion that public firm disclosures provide information that facilitates patent transactions, we find patent sales are positively related to Edgar download activity. Our results speak to an important, but previously unexplored externality of financial statement disclosures – their contribution to a well-functioning secondary patent market.