Firms Innovation Disclosure and Their Banking Relationship

Innovating firms face a choice whether to patent its innovation or keep it as a trade secret. US National Science Foundation’s Business R&D and Innovation Survey in 2013 found that 41% R&D-doing firms find patents important and 67% find trade secrets important. Firms might consider that information disclosed in a patent is only imperfectly protected by the patent. Potential rivals, especially in other jurisdictions, could make use of this information and introduce a competing product that would threaten innovating firm’s market position.

On the other hand, the decision whether to patent the innovation or not is also interlinked with firms’ financing decisions as financiers such as banks might use the hard information available in patents in their decisions whether to provide funding to the firms. Firms that do not publicly disclose verifiable information about innovation might find it difficult to get financing, especially if they do not have prior relationships with the banks. Such relationship banks know that such firms would find it harder to switch lenders and thus charge higher interest rates.

In a recent paper, we explore the interaction between a firm’s financing choices and its decision on whether to patent an innovation or keep it secret. To examine a shock to innovation disclosure, we study the American Inventor’s Protection Act (AIPA) that made firms’ patent applications public 18 months after filing, rather than when granted, which typically happens more than 18 months after patent’s filing. This meant that firms with more publicly available credible information about innovation could get more options from different banks. Indeed, we find that such increased innovation disclosure helps firms switch lenders, resulting in lower cost of debt, and facilitates their access to syndicated-loan and public capital markets.

Our evidence supports the ideas that innovation disclosure matters for credit markets and that credible information about innovation makes the credit markets more competitive.