The Mitigating Effect of Pending Patent Disclosure on Myopic R&D Underinvestment

Abstract

Guided by prior theoretical studies of real effects of disclosure, we investigate whether pending patent disclosure under the American Inventor’s Protection Act (AIPA) can mitigate managerial myopic underinvestment in R&D. When there is limited information on R&D payoff, investors tend to fixate on earnings when valuing firms, which motivates managers to underinvest in R&D myopically. The AIPA requires pending patent disclosure within 18 months of patent application. Such disclosure provides timely, detailed, and credible information on R&D payoff and can serve as an additional signal of firm value, reduce investors’ fixation on earnings, and mitigate R&D underinvestment. We find that pending patent disclosure under the AIPA significantly mitigates R&D underinvestment, especially for firms that face greater pressure to meet or beat earnings targets. We also find that the mitigating effect is stronger for firms with more analysts following, higher institutional ownership, and more unique technologies.