Patent and Innovation-Driven Performance in Venture ... · reflecting public information on...

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Patent and Innovation-Driven Performance in

Venture Capital-Backed IPOs

Jerry Cao

Assistant Professor of Finance

Singapore Management University

&

Co-director of Asia Private Equity Institute

[email protected]

Fuwei Jiang

Singapore Management University

[email protected]‎

Jay R. Ritter

Cordell Professor of Finance

Warrington College of Business Administration

University of Florida

[email protected]

This draft: August 19, 2013

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Patent and Innovation-Driven Performance in

Venture Capital-Backed IPOs

Abstract

We study the effect of patents as a proxy for innovation on the long-run performance

of Venture Capital (VC)-backed initial public offerings (IPOs). VC-backed IPOs with

successful patent filings prior to the IPO substantially outperform those without patent

filings. Patents act as the dominant factor leading to superior long-run performance for

VC-backed IPOs, especially in high-tech sectors, and in large size and high book-to-

market deciles. On the other hand, VC-backed IPOs without successful patent filings

perform similarly to non-VC-backed IPOs. Overall, this paper suggests that patents and

innovations in general are critical in understanding the performance of VC-backed IPO

firms.

Keywords: Initial public offerings, Venture capital, Patents, Innovation, Long-run

performance

JEL: G14 G24 G30

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I. Introduction

Ritter (1991, 2011), Loughran and Ritter (1995), Gompers and Lerner (2003), and

others document the underperformance of initial public offerings (IPOs) in the US. Brav

and Gompers (1997) find that venture capital (VC)-backed IPOs outperform non-VC

backed IPOs, and that VC-backed IPOs do not significantly underperform benchmarks

matched by size and book-to-market ratio.

The evidence on the long-run performance of IPOs can be summarized as follows:

On average, IPOs have low returns in the three years after the IPO, measured from the

first closing market price. The low returns are due to both successful market timing

effects (Greenwood and Hanson, 2012) and abnormal performance relative to the market.

The IPO universe, however, is intensive in small growth stocks with high capital

expenditures and high R&D expenditures. Size, book-to-market, CAPEX, and R&D have

all been shown to explain cross-sectional patterns in stock returns in general.

Consequently, the main question is after one controls for known cross-sectional effects,

does knowing whether or not a stock was a recent IPO have any incremental return

predictability effect?

We contribute to this literature by examining innovation-driven performance for

VC-backed IPOs. Our primary empirical findings are two-fold. First, within the class of

VC-backed IPOs, those with successful pre-IPO patent filings have substantially

outperformed, whereas other VC-backed IPOs have not. Second, the superior

performance of VC-backed IPOs relative to other IPOs has reversed for IPOs during the

1999-2000 bubble periods and later. For 1981-1998, VC-backed IPOs produced mean 3-

year buy-and-hold market-adjusted returns of -9.7%, versus -30.4% for non-VC-backed

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IPOs. For 1999-2006, VC-backed IPOs underperformed by -31.4%, versus -4.2% for

non-VC-backed IPOs.

Venture capitalists specialize in evaluating and monitoring startup and growth

companies. They provide pre-IPO capital and also provide both advice and certification

and, potentially, additional capital. Innovation activity of VC-backed firms is thus less

dependent upon internally generated cash flows than non VC-backed firms. Innovation is

crucial‎ for‎ improvements‎ in‎ companies’‎ productivity,‎ future‎ profitability, and, more

generally, economic growth. Evidence suggests that the social gains to innovation exceed

the private gains by a considerable amount (Griliches, 1992; Hall, 1996). Therefore, it is

no surprise that governments around the globe have been eager to encourage venture

capital activity, with the aim of boosting innovation (Kortum and Lerner, 2000; Lerner,

2012). Supporting the premise that VC activity spurs innovation, Kortum and Lerner

(2000) find that increases in venture capital activity in an industry are associated with

significantly higher patenting rates.

In this paper, we investigate the effects of innovation on the long-run performance

of VC-backed IPOs. A growing literature shows that the market may be inefficient in

reflecting public information on innovation.1 For example, Cohen, Diether, and Malloy

(2012) document that the investors do not correctly price the innovation ability of firms

in translating R&D into future sales growth. They show that a long-short portfolio

strategy that takes advantage of the information in past track records of innovations earns

abnormal returns of roughly 11% per year. However, most of the research focuses on

1 Previous studies identify various innovation measures with predictive power for future stock returns, including the

R&D capital to market value ratio (Lev and Sougiannis, 1996; Chan, Lakonishok, and Sougiannis, 2001; Li, 2011),

R&D growth (Eberhart, Maxwell, and Siddique, 2004; Lev, Sarath, and Sougiannis, 2005; Hsu, 2009), patents and

citations (Deng, Lev, and Narin, 1999; Gu, 2005; Hsu, 2009), innovation efficiency (Hirshleifer, Hsu, and Li, 2013),

and innovation ability (Cohen, Diether, and Malloy, 2013).

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mature firms, and does not separately examine the young, startup, and high-growth firms

that characterize VC-backed IPOs. In filling this gap, we seek to predict the future

(abnormal) performance of VC-backed IPOs using an alternative ex ante measure of

innovation, cumulative total successful patent filings until the end of event year -3 prior

to the calendar year in which the IPO occurred.

This innovation measure presents a number of attractive properties. Previous

research has used R&D capital-based measures to predict stock returns, with R&D capital

being the sum of unamortized past R&D expenditures. However, R&D expenditures from

several years before the IPO are unlikely to be observable for most IPOs.2 In contrast,

successful patent filings of VC-backed IPOs before the IPO are readily available from the

United‎ States‎ Patent‎ and‎Trademark‎Office‎ (USPTO)’s‎website.‎ Furthermore, although

we acknowledge that patents are not a perfect measure of innovation (for example, many

inventions are protected as trade secrets, such as the formula for Coca-Cola), patents

remain the most important and direct measure of the‎ quality‎ and‎ extent‎ of‎ firms’‎

innovations (Griliches, 1990). They are valuable materialized innovation outputs and are

actively traded in intellectual property markets. In addition, our usage of successful

patent filings is consistent with Lerner, Sorensen and Stromberg (2011), who state that

the use of patents as a measure of innovative activity is widely accepted in the literature.

We examine how patents play a role in the stock price performance of VC-backed

IPOs using a sample of 2,511 VC-backed IPOs from 1981-2006. To do this, we collect a

comprehensive sample of VC-backed‎IPO‎firms’ patent filing information before the IPO

from‎ the‎NBER’s‎ patent‎ database. We find that patent filings before the IPO reliably

2 For example, R&D expenses from fiscal years 3 to 7 years before the IPO are needed to calculate R&D capital in the

innovation efficiency measure of Hirshleifer, Hsu and Li (2012). Most young firm IPOs, however, do not report audited

financial statements from fiscal years that are more than 3 years old.

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predict the long-run performance of VC-backed IPOs. The USPTO patent information

contained in the NBER patent database includes the filing years and firm names only for

patents that were subsequently successfully granted. Thus, we have the filing years for

patents that were subsequently granted, but not the filing years for patent filings that were

subsequently denied. Hall, Jaffe, and Trajtenberg (2001) show that it takes about two

years after the filing to grant a patent, and the application-grant lags have shortened over

time. For successful patent filed in calendar year t during the late 1990s, about 85% are

granted by the end of calendar year t+2 after the filing year, and about 95% by the end of

calendar year t+3. We address the look-ahead bias associated with using successful patent

filings by using filings that were filed by the end of calendar year -3 prior to the calendar

year of the IPO, so that the successful patent filings information are almost always

publicly known before the IPO. For example, for an IPO during 2005, the patent filing

date must be in 2002 or earlier.

The outperformance of VC-backed IPOs with successful patent filings is both

economically and statistically strong in cross-sectional and calendar-time analysis. For

example, the value-weighted calendar-time portfolio of VC-backed IPOs with successful

patent filings, based on one or more successful patent filings up to event year -3 before

the IPO year, has a Fama-French 3-factor alpha of about 11% annually in the three years

after the IPO. In contrast, VC-backed IPOs without successful patent filings only perform

similarly or slightly better than non-VC-backed IPOs, with Fama-French alphas

insignificantly different from zero. Hence patents are critical in determining the stock

returns of these new issuers. Furthermore, successful patent filings are more important

predictors of abnormal performance for VC-backed firms among large firms than small

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firms, i.e, the value-weighted results are stronger than the equally weighted results.

Among VC-backed firms with patents, those having no citations or low citations as of the

end of the calendar year before the IPO show even stronger outperformance than others.

These findings suggest that patent information is important to understanding the financial

performance of VC-backed IPOs, especially the innovation information that may be hard

to process or access. The fact that subsequent stock returns can be predicted based on this

publicly observable information suggests that the market has historically not correctly

interpreted the value of patents.

This paper contributes to the literature on how investor underreacts to relevant

public information in innovations.3 The future profit from patents can be long deferred,

highly uncertain, and difficult to project, since it requires analyzing future changes in the

economic fundamentals of a firm or its industry, as well as the potential paths from

patents to final marketable products. If so, Hall (1993) and Hall and Hall (1993) suggest

that investor might be myopic in pricing the future cash flows generated by innovations

and hence leading to undervaluation. In addition, Huberman and Regev (2001),

Hirshleifer, Hsu, and Li (2012), and others show that due to limited investor attention

investor may fail to fully and immediately incorporate patent information into stock

prices and hence lead to undervaluation.4 Overall, we posit that IPOs that have intensive

innovation activities may be undervalued, whereas IPO firms that are less intensive in

innovations may be overvalued. The initial misevaluation should manifest itself in long-

3 Ritter (1991), Lerner (1994), Loughran and Ritter (1995, 2000), Baker and Wurgler (2000), and Hirshleifer (2001)

discuss a behavioral explanation for poor performance subsequent to equity offerings. They argue that stock prices

periodically diverge from fundamental values, and that managers and investment bankers take advantage of overpricing

by selling stock to overly optimistic investors.

4 Merton (1987), Hirshleifer and Teoh (2003), Peng and Xiong (2006), DellaVigna and Pollet (2009), and Hirshleifer,

Lim, and Teoh (2009), among others, analyze how limited investor attention affects stock prices and can cause market

underreaction.

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run abnormal returns.5

In addition to contributing to the literature relating innovation to subsequent stock

returns, our findings add to an extensive literature documenting the cross-sectional

patterns in the long-run performance of IPOs. Brav and Gompers (1997) find that VC-

backed IPOs do not underperform. Carter, Dark and Singh (1998) show that issuers using

high-prestige underwriters do not underperform. Teoh, Welch and Wong (1998) report

that issuers with low discretionary accruals do not underperform. Chan et. al. (2008)

examine discretionary accruals, VC-backing, and underwriter prestige, and report results

confirming the findings of the original authors. Cao and Lerner (2009) find that PE-

backed IPOs do not underperform the market on average. Ritter (2011) reports that

issuers with pre-IPO annual sales of more than $50 million do not underperform the

market. We show that our results are robust by the inclusion of these predictors in our

tests, suggesting that innovation is a new and previously undetected predictor for the

cross-section of long-run performance of VC-backed IPOs.

The rest of this paper is organized as follows. Section II discusses the construction

of the data set employed in the study. Section III presents the basic event-time and

calendar-time analyses of long-run performance. Multivariate regression analyses are

discussed in Section IV. The final section concludes the paper.

II. Data, Sample and Methods

Our sample consists of firms in the intersection of the Thomson-Reuters Securities

Data Company (SDC) new issues database, the Thomson VentureXpert database, the

5 Another possible explanation is that innovative VC-backed firms maintain comparative advantage relative to less

innovative ones and hence they exhibit superior performance in the long run, with investors not anticipating this

persistence.

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NBER patent dataset, and the Center for Research in Security Prices (CRSP) database.

We obtain the IPO date, offer price, and underpricing from the SDC new issues database

from 1981 to 2006, with numerous fill-ins of missing data and corrections based upon

information from Dealogic for 1990-2008, the Graham Howard-Todd Huxster set of IPO

prospectuses from 1975-1996 given to Jay Ritter, EDGAR for 1996-2008, and other

sources. We exclude closed-end funds, Real Estate Investment Trusts, banks and S&Ls,

American Depository Receipts, unit offerings, limited partnerships, and IPOs with an

offering size smaller than $1.5 million, an offering price of under $5 per share, or

companies not listed on CRSP within six months of the IPO date.

An IPO is classified as venture backed based upon venture funding information from

the Thomson Reuters VentureXpert database, with numerous alterations based upon

inspection of the prospectuses. The Thomson Reuters VentureXpert database provides

information on buyout and venture capital firms and their investments. This database

does not differentiate between venture capital financing and growth capital financing. A

growth capital investment, for example, might involve expansion capital for a retail

clothing store chain. About 10% of what the VentureXpert database classifies as VC-

backed would likely be classified as growth capital-backed.

Next, we collect information on patent applications from 1976 to 2005 from the

updated NBER patent dataset and match them to the VC-backed companies using

GVKEY and CUSIP identifiers. The NBER patent dataset contains information about all

patents that were successfully granted by the USPTO from January 1, 1976 to December

31, 2006. It is worth noting that, following Kortum and Lerner (2000) and Hirukawa and

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Ueda (2008), we date all patent filings by their application years,6 which USPTO

discloses only for patents that were subsequently granted. Thus, we have the filing years

for patents that were subsequently granted, but not the filing years for patent filings that

were subsequently denied. Following the literature, we measure the VC-backed‎ firms’‎

yearly patenting activities with their number of new successful patent filings in every

calendar year. In Table A1 of the Internet Appendix that accompanies this paper, we

report patent information from both the NBER patent database and the IPO prospectus

for‎some‎firms‎(all‎ table‎numbers‎with‎an‎“A”‎prefix‎appear‎ in‎ the‎ Internet‎Appendix).‎

The comparison shows that, although the NBER patent database summarizes the patent

filing information quite well on average, the correlation is not great, which is one reason

that we use a simple 0-1 classification scheme.

We then collect stock returns on common stocks listed on the New York Stock

Exchange (NYSE), American Stock Exchange (AMEX), and NASDAQ from the CRSP

database, and accounting data of the issuing firms from the COMPUSTAT database.

These sources leave us with a final sample of 2,511 VC-backed IPOs and 4,568 non-VC-

backed IPOs from 1981-2006.

[Insert Table 1 Here]

Table 1 presents the distribution of the sample by year. The sample consists of 2,511

VC-backed IPOs between January 1981 and December 2006. The table reports the total

number of VC-backed IPOs and the total number of successful patent filings over the five

calendar years before the calendar year during which the IPO occurred by these newly

listed companies. The last two columns show the percentages of VC-backed IPOs that

6 As argued in Hall, Jaffe, and Trajtenberg (2001) and many other studies, application dates are the most appropriate

time placer for patents because inventions begin entering real economies once they appear. And patent protection starts

from the application dates.

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have successful patent filings over the five calendar years either before or after the IPO

year.

This table highlights the increase in VC-backed IPO activities in the 1990s. The

number of VC-backed firms going public hit a peak in 1999 and 2000 during the tech

bubble. The time series suggests that VCs are more likely to take portfolio companies

public when public market valuations are high, consistent with Lerner (1994). The

percentage of VC-backed companies having successful patent filings from event year +1

to +5 following the IPO is 40.5%, while the percentage of VC-backed companies having

successful patent filings from event year -5 to -1 before the IPO is 36.3%, where event

year 0 is the calendar year in which the IPO occurred. There is a strong pattern of

persistence in successful patent filings: pre-IPO successful patent filings have a

correlation coefficient of 0.63 with post-IPO successful patent filings. The results

indicate that VC-backed companies that have innovation abilities before the IPO continue

to file patents and maintain innovation after the IPO.7 Table 1 does not report successful

patent filings over event years +1 to +5 for IPOs issued from 2001 to 2006 due to the

increasing missing observation problem (i.e., it takes about two years for the USPTO to

grant a valid patent application, thus many patents applied for in 2004 or later may have

not yet been granted before the end of 2006 due to the application-grant lag).

[Insert Figure 1 Here]

Figure 1 shows the average number of new successful patent filings per firm per

event year over [-5, 5] event years before and after the calendar year of the IPO, where

event year 0 is the calendar year during which the IPO occurred. The solid line depicts

7 Bernstein (2012) and Ferreira, Manso, and Silva (2012) provide evidence on the impact of going public on firms’

innovation activities.

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the yearly average number of new successful patent filings for all the 2,511 VC-backed

IPOs between January 1981 and December 2006; The dashed line shows the yearly

average number of new successful patent filings for the subset of 637 VC-backed firms

with successful patent filings, based on having one or more successful patent filings until

the end of event year -3 prior to the IPO year.

According to the solid line of Figure 1, perhaps not surprisingly, we observe a steep

uptrend in the average number of successful patent filings per firm per event year from

event year -5 (five years before the IPO year) to event year +5 (five years after the IPO

year) relative to the calendar year of the IPO. On average, in event year -3 there is around

0.6 new successful patent filing, and in year +3 there are almost 2.1 new successful patent

filings for the surviving firms, with the (not shown) cumulative number of about 15

during event year from -5 to +5. If a company is delisted after the IPO, the patent filing

counts stop for this company in the delisting year and subsequent years, and the average

number of successful patent filings per firm per event year is calculated based on the

surviving firms.8 Successful patent filings dated by application date are counted until the

end of calendar year 2005 due to the data availability of the NBER patent database. A

similar uptrend is observed, with a much greater magnitude, in the dashed line, which

shows the average number of successful patent filings per year conditioned on a firm

having at least one successful filing prior to event year -3.

8 When a firm is acquired/merged/spun-off, the NBER patent database assigns its patents to the new owner. At present

it does not track ownership changes when patents are sold independently of their initial assigned owners.

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III. The Impact of Innovation on VC-backed IPOs Performance

A. Firm Characteristics and Accounting Performance

Before formally analyzing the stock price performance of VC-backed IPOs related

to patents, we summarize the characteristics and accounting performance of VC-backed

IPOs without and with successful patent filings in Table 2. Because of the delay between

the filing and granting of a patent, and because the NBER database only reports the

calendar year of the application date, we only use information for successful patent

filings before the end of event year -3, where event year 0 is the calendar year of the IPO,

to categorize the VC-backed IPOs. Thus, depending on the timing of the patent

application and the date of the IPO within their calendar years, at least 24 months and as

many as 47 months have transpired between the date of the patent application and the

date of the IPO. The firm characteristics include the following: equity market

capitalization, total assets, the ratio of the book value to the market value‎ of‎ a‎ firm’s‎

equity, the ratio of operating income to assets, the ratio of net income to assets (ROA),

the capital expenditures (CAPEX)-to-assets ratio, the debt-to-assets ratio, the long-term

debt-to-assets ratio, the R&D-to-assets ratio, and the R&D-to-sales ratio. Table 2 reports

the sample means of variables computed for the fiscal year in which the IPO occurred,

and one, two, three, four and five years after the IPO.9 2,444 VC-backed issuing firms

have financial information in COMPUSTAT for the fiscal year in which the IPO occurred,

with the sample size falling to 1,390 five years after the IPO due to delisting. All

variables are computed using data at the end of the fiscal year, as reported by

COMPUSTAT.

9 We winsorize all variables at the 1% and 99% percentiles to eliminate outliers, and set missing values to zero before

calculating the means.

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VC-backed IPOs with successful patent filings have about two times higher R&D-

to-assets and R&D-to-sales ratios than those without successful patent filings.10

The

differences in the R&D-to-assets ratio between VC-backed IPOs with and without

successful patent filings are 5.9%, 6.2%, 6.9%, 7.2%, 6.4%, and 6.7% at the IPO year and

one, two, three, four, and five years after the IPO, respectively. The pattern in Table 2

shows a downtrend in the R&D-to-sales ratio from the IPO year to five years after the

IPO, while the R&D-to-assets ratio is relatively stable. The mean R&D-to-sales ratio of

0.33 to 0.86 in various years is high because many biotech firms have ratios far above

1.00. The average VC-backed IPO without successful patent filings is more levered than

the average VC-backed IPO with successful patent filings at the IPO year and five years

later, measured with debt/assets or long-term debt/assets. Both VC-backed IPOs with and

without successful patent filings have negative profitability on average after the IPO, and

show similar levels of CAPEX/sales.11

B. Underpricing

An extensive literature on IPOs finds sizeable positive average returns on the first

day of trading. Megginson and Weiss (1991) show that US VC-backed IPOs have lower

first-day returns than non-VC-backed IPOs during 1983 through 1987, which they

attribute to VC certification reducing information asymmetry between investors and

issuing firms. Evidence from recent years suggests that US VC-backed IPOs are more

10 The higher average R&D-to-sales ratio relative to the R&D-to-assets ratio is partly due to the low revenue of most

biotech stocks at the IPO year and subsequent years. For example, for the VC-backed biotech IPOs with successful

patent filings, the average sales at the IPO year is only of $35 million, and the median sales is even smaller ($6 million),

generating a high average R&D-to-sales ratio of 1.90. We observe the same pattern for VC-backed biotech IPOs

without successful patent filings as well.

11 Table A3 summarizes the characteristics and accounting performance of VC-backed IPOs without and with

successful patent filings sorted on size or book-to-market ratio. VC-backed IPOs in large size or value terciles (high

book-to-market ratio) have better profitability than those in small size or growth terciles (low book-to-market ratio).

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underpriced than other IPOs (e.g., Loughran and Ritter, 2004). Liu and Ritter (2011)

report that during 1993-2008 VC-backed IPOs with subsequent coverage from an all-star

analyst affiliated with a lead underwriter are underpriced by 21% more than non-VC-

backed IPOs (e.g., 32% vs. 12%), but other VC-backed IPOs are not reliably underpriced

more or less than non-VC-backed IPOs.12


Table 3 reports summary statistics for first-day returns for VC-backed IPOs without

and with successful patent filings.13

The average first-day return across VC-backed firms

without successful patent filings during the period January 1981 to December 2006 is

29.0%, a level only slightly higher than the 27.1% of VC-backed firms with successful

patent filings. The 1998-2000 dotcom bubble had a striking effect on first day returns for

VC-backed IPOs without or with successful patent applications, which reached average

levels of 92.4% and 94.2%, respectively, during this bubble period. In general, there is

little difference in the distribution of first-day returns between the two categories of VC-

based IPOs.

C. Firm Level Stock Performance

The weight of evidence on IPOs in general suggests significant underperformance in

the aftermarket, at least for small IPOs. Brav and Gompers (1997) find that VC-backed

IPOs outperform non-VC-backed IPOs in equal-weighted returns. In this section, we

present the firm level analyses of long-run performance of VC-backed IPOs with and

12 Liu and Ritter (2011, column 1 of table 5) report a coefficient of 2.88 on a VC dummy and 18.03 on an interaction of

a VC dummy and an all-star analyst dummy, giving a total effect of 20.91% in an underpricing regression.

13 To determine the closing price, we use the first available closing price data from CRSP within 14 calendar days after

the offering. For the small number of IPOs for which CRSP data are not available, we try to obtain the closing price on

the first day of trading from SDC. If that is not available, the close on the second day or the end of the first week of

trading from SDC is used.

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without successful patent filings. Each IPO is weighted equally.

In examining IPO long-run performance, we employ various performance measures

that have been used in the literature. These measures include buy-and-hold returns (raw

returns and market-adjusted abnormal returns), CAPM alphas, Fama-French (1993)

alphas, and Fama-French-investment alphas (Lyandres, Sun and Zhang, 2008).14

If the

sample firm gets delisted, the performance measures are calculated up to the delisting

date.

In calculating CAPM alphas, for each firm we run the capital asset pricing model

(CAPM) regressions of monthly firm excess returns on the market factor for 24, 36, 48,

and 60 months after the IPO,

𝑅𝑖,𝑡 − 𝑅𝑓,𝑡 = 𝛼𝑖 + 𝛽𝑖(𝑅𝑚,𝑡 − 𝑅𝑓,𝑡) + 𝑒𝑖,𝑡,

where 𝑅𝑖,𝑡 − 𝑅𝑓,𝑡 is the return on stock 𝑖 in excess of the risk-free interest rate (the one-

month Treasury bill rate) at time t; and 𝑅𝑚,𝑡 − 𝑅𝑓,𝑡 is the value-weighted market return of

all NYSE/Amex/Nasdaq firms minus the risk-free rate at time t.

In addition, we run a Fama and French 3-factor regression,

𝑅𝑖,𝑡 − 𝑅𝑓,𝑡 = 𝛼𝑖 + 𝛽𝑖(𝑅𝑚,𝑡 − 𝑅𝑓,𝑡) + 𝑠𝑖𝑆𝑀𝐵𝑡 + ℎ𝑖𝐻𝑀𝐿𝑡 + 𝑒𝑖,𝑡.

We employ as independent variables 𝑅𝑚𝑡 − 𝑅𝑓𝑡 ; 𝑆𝑀𝐵𝑡 , the difference each month

between the return on small- and big-capitalization firms; and 𝐻𝑀𝐿𝑡, the difference each

month between the return on high and low book-to-market stocks.15

Moreover, we calculate Fama-French-Investment alphas by regressing the IPO

excess returns on the 3 Fama-French factors and the Lyandres, Sun and Zhang (2008)

14 The Fama-French and investment factor portfolios are themselves partly composed of new issues, and the small size,

high growth, and high investment portfolios may have lots of IPOs, so there is a “factor contamination” problem that

biases the estimated intercept towards zero, as discussed in Loughran and Ritter (2000).

15 The Fama-French factors are available at http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html.

http://mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html

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investment factor,

𝑅𝑖,𝑡 − 𝑅𝑓,𝑡 = 𝛼𝑖 + 𝛽𝑖(𝑅𝑚,𝑡 − 𝑅𝑓,𝑡) + 𝑠𝑖𝑆𝑀𝐵𝑡 + ℎ𝑖𝐻𝑀𝐿𝑡 + 𝑛𝑖𝐼𝑁𝑉𝑡 + 𝑒𝑖,𝑡,

where the investment factor 𝐼𝑁𝑉𝑡 , long in low investment stocks and short in high

investment stocks, is obtained from Hou, Xue, and Zhang (2012).


Panels A and B of Table 4 summarize the average long-run raw and abnormal

returns in the five years following the IPOs of 1,874 VC-backed IPOs without successful

patent filings and 637 VC-backed IPOs with successful patent filings, respectively, based

on the successful patent filings up to event year -3 before the IPO year. The firm level

performance measures are the raw (unadjusted) buy-and-hold returns, market-adjusted

buy-and-hold returns using the CRSP value-weighted NYSE/Amex/Nasdaq index, the

average monthly market-adjusted returns, and the average monthly alphas (abnormal

returns) from the capital asset pricing model (CAPM) (also‎ known‎ as‎ Jensen’s‎ alpha),

from a three-factor Fama and French model, and from a Fama-French-Investment 4-

factor model. The average buy-and-hold returns and average monthly returns are

computed on the basis of monthly stock returns over 24, 36, 48, and 60 calendar months

starting from the closing price on the last trading day of the IPO month, and do not

include the first-day return or returns until the end of the IPO calendar month. If a sample

firm gets delisted, the IPO returns and the corresponding benchmark returns are

calculated using data up to the delisting date. When available, we include the firm's

delisting return.

As a benchmark, Panel C of Table 4 reports the long-run performance of 4,568 non-

VC-backed IPOs in the five years after the IPO. Consistent with the literature, non-VC-

18

backed IPOs underperform. The average buy-and-hold market-adjusted return is -17.3%

two years after the IPO, and increases to -38.9% five years after the IPO. In addition, all

the average monthly Fama-French alphas of non-VC-backed IPOs are negative, ranging

from -0.62% to -0.72%. The average monthly Fama-French-Investment alphas also show

underperformance, ranging from -0.62% to -0.70%.

Panel A of Table 4 shows that 1,874 VC-backed firms without successful patent

filings perform similarly compared to the non-VC-backed IPOs, and only deliver an

average raw buy-and-hold return of 17.8% over three years, and 39.1% over five years

after the IPOs. In contrast, Panel B shows that VC-backed firms with successful patent

filings deliver a substantially higher average raw buy-and-hold return of 29.7% over three

years and 62.4% over five years. When the buy-and-hold return is adjusted by the value-

weighted compounded market return, the difference between the two categories in the

average buy-and-hold market-adjusted returns of VC-backed IPOs is 13.7% (-10.2% vs.

+3.5%) after two years, growing to 24.9% (-21.6% vs +3.3%) after five years.

According to Panel A of Table 4, all of the average monthly Fama-French alphas of

VC-backed IPOs without successful patent filings are negative in the five years after the

IPO, ranging from a monthly average of -0.57% in the first two years to a monthly

average of -0.45% in the first five years. By comparison, Panel B shows that all of the

average monthly Fama-French alphas of VC-backed IPOs with successful patent filings

are positive, in the range of 0.28% to 0.52%. Therefore, VC-backed IPOs with successful

patent filings substantially outperform VC-backed IPOs without successful patent filings

by about 0.97% per month in the five years after the IPO in terms of Fama-French alphas.

Moreover, the alphas from the Fama-French & investment factors also suggest that VC-

19

backed IPOs with successful patent filings outperform those without successful patent

filings by about 1.06% per month. The results are also consistent with the average

monthly market-adjusted returns and average monthly‎Jensen’s‎alphas.16

In summary, the overall evidence from Table 4 suggests that VC-backed IPOs

without successful patent filings perform similarly to non-VC-backed IPOs and

underperform. In contrast, VC-backed IPOs with successful patent filings outperform all

benchmarks.17

Patents are important for high-tech firms while they may not be equally important in

non-high-tech sectors. We thus classify all VC-backed IPOs into high-tech (including

biotech) and non-high-tech groups according to standard industry classification codes

(SIC) at the IPO.18

We calculate‎ each‎ firm’s‎ three-year long-run performance using

alternative performance measures such as buy-and-hold raw and market-adjusted returns,

monthly raw and market-adjusted returns, Jensen’s alphas, Fama-French alphas, and

Fama-French-Investment alphas. The sample means of the non-high-tech, high-tech, and

biotech industries are reported in Table 5. Panel A reports the results for VC-backed IPOs

16 Table A4 shows that, for every size or book-to-market group, all the abnormal returns are negative for VC-backed

IPOs without successful patent filings. In contrast, almost all the performance measures for VC-backed IPOs with

successful patent filings are positive. Thus VC-backed IPOs with successful patent filings consistently outperform

those without successful patent filings using different performance measures across all three size categories and all

three book-to-market categories. The outperformance of VC-backed IPOs with successful patent filings is especially

strong for those with large size or high book-to-market ratio. For example, the three-year buy-and-hold market-adjusted

returns of VC-backed IPOs with successful patent filings are as high as 23.1% and 16.5% on average for the large size

and value groups, respectively. In addition, VC-backed IPOs with successful patent filings in the large size and value

terciles earn average monthly Fama-French alphas of 0.43% and 1.26%, respectively. Note that we utilize share

outstanding reported by SDC, because CRSP only reports traded shares when a firm has dual-class shares and about 5%

of our sample IPOs have a dual class structure. Moreover, the shares outstanding in CRSP will be different from that in

COMPUSTAT used in Table 2 when firms having dual-class shares.

17 Our results are robust to alternative lags between the patent application dates and IPO dates. For example, we find

similar patterns in Table A2 where an issuing firm is clarified as having successful patent filings based on at least one

successful patent filing up to event year -2 prior to the IPO year.

18 An‎IPO’s‎ industry‎ is‎determined‎by‎ its‎primary‎3-digit SIC code at the IPO. High-tech‎ industries‎are‎classified‎as‎

belonging to SIC codes 283 and 874 (biological products, genetics, pharmaceuticals, and biological research), 481

(high-technology communications), 365-369 (electronic equipment), 482-489 (communication services), 357

(computer hardware), and 737 (computer software).

20

without successful patent filings while Panel B reports the results for those with

successful patent filings.


Successful patent filings matter, especially for VC-backed IPOs in high-tech sectors:

the outperformance is strong with economically large monthly Fama-French alphas of

0.92%. VC-backed IPOs with successful patent filings in the biotech industry also

outperform the market benchmark but on a smaller scale. However, successful patent

filings carry only limited information about the performance for VC-backed IPOs in non-

high-tech sectors, which show similar underperformance using buy-and-hold market-

adjusted returns. Using monthly alphas, however, there is greater underperformance for

the VC-backed IPOs without successful patents.

D. Subperiod Firm Level Performance

This subsection refines the firm level stock price performance results reported in the

previous section by assessing the three-year long-run performance of VC-backed IPOs

with and without successful patent filings in different subsample periods and cohort years.

This analysis is motivated by the evidence that IPO long-run performance varies across

financial market cycles. Loughran and Ritter (2000), among others, find that IPO

performance is particularly poor following hot IPO markets.

Table 6 reports the average firm level three-year stock performance measures over

four subperiods: 1981-1989, 1990-1998, 1999-2000, and 2001-2006. Panels A and B of

Table 6 report the subperiod results of 1,874 and 637 VC-backed IPOs without and with

successful patent filings, respectively, based on at least one successful patent filing in

event year -3 or earlier. Panel C reports the subperiod results for all 2,511 VC-backed

21

IPOs. Panel D reports the subperiod results for 4,568 non-VC-backed IPOs. The three-

year performance metrics for each IPO firm include buy-and-hold raw and market-

adjusted returns, monthly raw and market-adjusted‎returns,‎Jensen’s‎alphas,‎Fama-French

alphas, and Fama-French-Investment alphas, with the returns starting from the closing

price on the last trading day of the calendar month of the IPO. If a sample firm gets

delisted, the IPO returns and the corresponding benchmark returns are calculated using

data up to the delisting date.


Consistent with the literature, the long-run abnormal performance of IPOs varies

over time. Panels A and B show that, among VC-backed IPOs, those with successful

patent filings outperform those without successful patent filings during all but the 2001-

2006 period. VC-backed IPOs with successful patent filings generate sizable positive

Fama-French alphas and Fama-French-Investment alphas across every subperiod except

the decade of the 2000s.

Brav and Gompers (1997) show that VC-backed IPOs outperform non-VC backed

IPOs, and that VC-backed IPOs do not significantly underperform. Consistent with their

findings, a comparison of Panels C and D shows the superior performance of VC-backed

IPOs relative to other IPOs in 1990-1998. This pattern is reversed, however, for IPOs

during the 1999-2000 bubble period and later. In Panel C, the average 3-year buy-and-

hold market-adjusted return for the 766 VC-backed IPOs from 1999-2006 is -31.4%. In

Panel D, the average 3-year buy-and-hold market-adjusted return for the 783 non-VC-

backed IPOs from 1999-2006 is -4.2%. Thus, for 1999-2006, VC-backed IPOs have

underperformed non-VC-backed IPOs.

22

Table 7 presents three-year buy-and-hold returns for VC-backed IPOs without and

with successful patent filings over each cohort year, with the returns starting from the

closing price on the last trading day of the calendar month of the IPO. For every firm, we

calculate the 36-month buy-and-hold return, the compounded market benchmark return,

and wealth relatives of each VC-backed IPO and report their average (equal-weighted in

Panel A and value-weighted in Panel B) for the cohort year. If a sample firm gets delisted,

the IPO returns and the corresponding benchmark returns are calculated using data up to

the delisting date. Wealth relatives are calculated as

𝑊𝑒𝑎𝑙𝑡ℎ 𝑅𝑒𝑙𝑎𝑡𝑖𝑣𝑒 = ∑(1 + 𝑅𝑖,𝑇)/ ∑(1 + 𝑅𝑏𝑒𝑛𝑐ℎ 𝑖,𝑇),

where 𝑅𝑖,𝑇 is the buy-and-hold return on IPO i for holding period of length T and

𝑅𝑏𝑒𝑛𝑐ℎ 𝑖,𝑇 is the benchmark buy-and-hold return on the value-weighted market portfolio

of all NYSE/Amex/Nasdaq firms over the same period. The value weights are based on

the market capitalization using the first-day closing prices in CRSP, and are converted

into dollars of 2006 purchasing power using the Consumer Price Index to adjust for

inflation. Wealth relatives as a measure of performance were first introduced by Ritter

(1991), and are identical to the public market equivalents used in Kaplan and Schoar

(2005).


According to Table 7, three-year buy-and-hold returns and wealth relatives have

large variations over time. These results are largely consistent with the results of Ritter

(1991) and Ritter and Welch (2002). Nevertheless, VC-backed IPOs with successful

patent filings substantially outperform those without patent filings on average. For

example, weighting each IPO equally, Panel A shows that the VC-backed IPOs from 1981

23

to 2006 without successful patent filings show an average equally weighted 3-year buy-

and-hold return of 17.8% relative to 37.9% for the value-weighted market index. In

comparison, VC-backed IPOs with successful patent filings have an equally weighted

average 3-year buy-and-hold return of 29.7%, relative to 34.7% for the market index. The

average 3-year wealth relative for the 637 VC-backed IPOs with successful patent filings

is 0.96, versus only 0.85 for the 1,874 VC-backed IPOs without successful patent filings.

In Panel B of Table 7, we employ inflation-adjusted (2006 purchasing power) value

weights for each cohort year, and VC-backed IPOs with successful patent filings show

significantly better performance, with an average wealth relative of 1.10, in contrast to

only 0.67 for those without successful patent filings.

E. Calendar-time Portfolio Performance

The firm level performance measures in event time suffer from cross-sectional

correlation, which is why we have not reported statistical significance measures in Tables

1-7. In this subsection, we report calendar-time long-run performance of VC-backed IPOs

with and without successful patent filings, weighting each time period equally rather than

weighting each IPO equally.19

Following Brav and Gompers (1997), we form monthly

portfolios of VC-backed IPOs without and with successful patent filings by including all

issues that were undertaken in the three years previous to the month of the observation.

We then calculate the monthly excess returns, defined as monthly returns of the equal- or

value-weighted return of these portfolios less the risk-free rate (the one-month Treasury

bill rate). The calendar-time portfolios are rebalanced every month, and the value weights

are‎based‎on‎the‎previous‎month’s‎month-end market values of the issuing firms.

19 A disadvantage of the calendar-time approach is that it tends to underestimate the level of underperformance when

the magnitude of abnormal underperformance is positively correlated with issuing activity (Loughran and Ritter, 2000).

24


Panel A of Table 8 reports Fama-French 3-factor time-series regression results for

calendar-time portfolios of VC-backed IPOs without and with successful patent filings

from the 347 months from February 1981 to December 2009. The equal-weighted

calendar-time portfolio of VC-backed IPOs with successful patent filings significantly

outperforms; the monthly Fama-French alpha is 0.55%, which is economically sizable

and statistically significant, with a t-statistic of 2.39. When the VC-backed IPOs with

successful patent filings are value-weighted, the outperformance is even stronger, with a

monthly Fama-French alpha of 0.90%, and a t-statistic of 2.68. Abnormal returns of 0.90%

per month correspond to approximately 11% per year.

By comparison, for both the equal- and value-weighted calendar-time portfolios of

VC-backed IPOs without successful patent filings, the Fama-French alphas are

insignificantly different from zero, suggesting that VC-backed IPOs without successful

patent filings in general perform as well as other firms with similar characteristics. As a

benchmark, the last panel of Table 8 shows that, while the alpha of the value-weighted

calendar-time portfolio of non-VC-backed IPOs is also insignificantly different from zero,

the equal-weighted portfolio of non-VC-backed IPOs significantly underperforms, with a

monthly Fama-French alpha of -0.66%.20

Next, we examine whether the outperformance of VC-backed IPOs with successful

patent filings is captured by existing innovation-related effects in the cross-section of

mature public firms. Specifically, we augment the Fama-French three-factor model with

the innovation ability factor (IAH) of Cohen, Diether, and Malloy (2012), who document

20 Loughran and Ritter (2000, Table 6) suggest that the alphas in Table 8 are biased upwards by approximately 18 basis

points‎per‎month‎due‎to‎“factor‎contamination.”

25

that the innovation ability of firms in translating R&D into future sales growth is a

positive predictor for the cross-section of stock returns. The IAH factor is the return

difference between a portfolio of stocks with high R&D and high innovation ability and a

portfolio of stocks with high R&D and low innovation ability.

Panel B of Table 8 shows that our findings generally remain unchanged by the

inclusion of the innovation ability factor. All the factor loadings on the innovation factor

are economically small (less than 0.05 in absolute value), and four out of six are negative.

The inclusion of the innovation factor has little impact on the abnormal returns of VC-

backed IPOs. For example, the value-weighted portfolio of VC-backed IPOs with

successful patent filings still generates abnormal return of 0.86% per month, with a t-

statistic of 2.59. We thus conclude that our findings are distinct from existing innovation-

related patterns such as those reported in Cohen, Diether, and Malloy (2013) and

Hirshleifer, Hsu, and Li (2013).21

Patent citation is an alternative metric of innovation, which reflects the observed

technology or economic quality of granted patents. The NBER patent database records

the number of citations received by the patents from the year granted until the end of

2006. Patent citations reflect the technology or economic significance of patents (e.g.,

Trajtenberg, 1990), but given the long time span in which they occur in the years after a

patent is granted, citations are a less obvious candidate for predicting stock returns.

Moreover, if future citations are used, they are subject to look-ahead bias because the

number of citations to be received by a patent is unknown at the time the patent is applied

for or granted. Nevertheless, Hirshleifer, Hsu and Li (2012) report that the correlation

21 In unreported results, we find that our findings are robust by the inclusion of additional factors such as a momentum

factor or an investment factor.

26

between‎a‎ firm’s‎patents‎granted‎scaled‎by‎R&D‎capital‎ and‎subsequent‎patent‎citation‎

counts scaled by R&D capital is 0.85. This high correlation suggests that successful

patent filings are likely to capture much of the valuation-relevant information contained

in patent citations. To check the robustness of our findings, we manually collect citation

data for each patent at each year for our patenting VC-backed IPOs and examine the

effect of citations received before the IPO on subsequent stock market performance, thus

avoiding a look-ahead bias.

To analyze the effects of citations, we classify the 637 VC-backed IPOs with

successful patent filings into low and high citations groups based on cumulative citations

prior to the calendar year of the IPO, respectively.22

Panel A of Table A5 shows that

while both low and high citations VC-backed IPOs show positive abnormal returns, the

low citations portfolio performs better. For example, the monthly Fama-French alpha is

1.35% for the value-weighted portfolio of VC-backed IPOs with low citations, while it is

only of -0.05% for the corresponding high citations portfolio. In Panel B, instead of low

and high citations categories, we create zero (without) and positive (with) citation

categories, and report qualitatively similar results.

These findings are consistent with our premise that patent information, especially

patents with low citations, is likely to be ignored by the market. The evidence suggests

that investors underestimate the economic importance of patents, and especially those

patents that have not generated enough citations at the time of going public.

Size and Book-to-Market are important firm characteristics related to long-run

performance. Table A6 analyzes the performance of calendar-time portfolios of VC-

22 Rather than using the cumulative number of citations through the end of 2006 in the NBER patent database, which

suffers from a serious look-ahead bias, we manually collect citation data for each patent for each calendar year for

every firm before the IPO, and use only the cumulative citations prior to the calendar year of the IPO.

27

backed IPOs formed on the basis of size and book-to-market ratio, following Brav and

Gompers (1997). In general, the abnormal returns are highest for the portfolios of larger

companies and value companies, with the IPOs with successful patent filings

outperforming those without.

IV. Cross-sectional differences across VC-backed IPOs

In this section, we use multivariate regression analyses to assess the effects of

patents on VC-backed IPO long-run performance in the three years after going public.

Table 9 reports the multivariate regression results. The dependent variable for columns (1)

to (3) in Table 9 is the buy-and-hold three-year market-adjusted return. The dependent

variable for columns (4) to (6) is the monthly Fama-French alpha estimated by running

firm-specific time-series regressions of monthly firm excess returns on the Fama and

French factors for 36 months after the IPO. If the sample firm gets delisted, the IPO

returns and corresponding benchmark returns are calculated using data up to the delisting

date. The variable of interest is the patent dummy, which is equal to one when the firm

has at least one successful patent filing up to the end of event year -3.

The sample consists of 2,511 VC-backed IPOs between January 1981 and December

2006. The sample size falls to 2,280 when we include many financial control variables:

the logarithm of inflation-adjusted sales (in millions of dollars of 2006 purchase power),

Tobin’s‎ Q,‎ underpricing,‎ the‎ debt-to-total assets ratio, the research and development

(R&D) expenses-to-sales ratio, and successful patent filings at the IPO year relative to

R&D expenditures ratio.23

All the financial variables are computed using data at the end

23 Tobin's Q is calculated as the market value of common equity at the IPO plus the book value of debt and preferred

equity divided by the book value of total assets. Debt is defined as long-term debt plus debt in current liabilities.

28

of the fiscal year of the IPO in COMPUSTAT. We also control for the logarithm of IPO

firm age at the IPO and underwriter reputation.24

All the regressions control for industry

and year fixed effects. Standard errors are clustered at the industry and year levels

(Petersen, 2009). Given that a number of the control variables are endogenous choices by

the issuing firms and VCs, these regressions should be interpreted as indicative of

correlation, not causation.


The multivariate regression results in Columns (1) to (3) of Table 9 show that VC-

backed IPOs with successful patent filings experience higher market-adjusted returns

over the three years after the IPO, even after the inclusion of different sets of control

variables. For the univariate regression in Column (1), the unconditional coefficient on

the patent dummy is 24.0 with a t-statistic of 2.42. In other words, having successful

patent filings leads to a significant increase of 24.0% in the buy-and-hold 3-year market-

adjusted return. Our results are unchanged, with the regression coefficients in the range

of 20.6 to 24.2, when further including many control variables such as sales,‎Tobin’s‎Q,‎

underpricing, the debt-to-market ratio, the R&D expenses-to-sales ratio, the patent

filings-to-R&D expenses ratio, IPO firm age, and underwriter reputation, as reported in

Columns (2) and (3).

Columns (4) to (6) show that, in the regressions that use the monthly Fama-French

alphas as the dependent variable, the patent dummy is always positively associated with

VC-backed‎ IPO‎ firm’s‎ long-run abnormal performance with economic and statistical

significance, regardless of the model specifications. The coefficients on the patent 24 Following Field and Karpoff (2002) and Loughran and Ritter (2004), IPO firm age is defined as the calendar year of

offering minus the calendar year of founding. The IPO founding dates and updated Carter and Manaster (1990) and

Carter, Dark, and Singh (1998) underwriter reputation rankings (on a 0 to 9 scale, with 9 being highest) are available

from Jay Ritter’s website.

29

dummy range from 0.75 to 0.88, indicating that the monthly abnormal returns increase by

0.75% to 0.88%, or annually up to about 11%.25

VC-backed companies with larger sales perform significantly better. This result is

consistent with Ritter (2011), who reports that long-run abnormal returns are much worse

for IPOs with inflation-adjusted pre-IPO annual sales of below $50 million in terms of

2005 purchasing power. In addition, consistent with Carter, Dark, and Singh (1998)

among others, we find that underwriter reputation is significantly positively associated

with long run abnormal returns of VC-backed IPOs. The R&D expenses-to-sales ratio

and patent filings-to-R&D expenses ratio have marginally positive impacts on the long

run abnormal performance, while the Tobin’s Q, underpricing, and leverage (debt-to-

assets ratio) have marginally negative impacts. The coefficient for IPO firm age has no

significant explanatory power.

V. Conclusions

In this paper, we examine the effect of patents on the long-run performance of VC-

backed IPOs using a large sample of VC-backed US IPOs from 1981 through 2006. We

find that VC-backed IPOs with successful patent filings three years before the IPO

outperform VC-backed IPOs without successful patent filings in both cross-sectional and

calendar-time analyses. Outperformance associated with successful patent filings is

especially strong in large size or value (high book-to-market) terciles, in high-tech sectors,

or in patenting firms without citations or with low citations. In contrast, VC-backed IPOs

without successful patent filings on average perform similarly to non-VC-backed IPOs.

25 In unreported results, we find that our findings are robust by the incorporate ion of VC characteristics such as VC

firm age and VC’s historical assets under management at the IPO, although the sample size drops sharply by more than

50% due to missing information on VC characteristics.

30

The outperformance for VC-backed IPOs with successful patent filings remains

strong after we control for size, value, and investment effects. In addition, our findings

are not driven by the existing innovation-related effects in the cross-section of stock

returns. For example, the calendar-time portfolio of VC-backed IPOs with successful

patent filings earns 11% annual abnormal return after controlling for the three Fama-

French factors and the innovation ability factor of Cohen, Diether, and Malloy (2012),

while the alpha of the portfolio of VC-backed IPOs without successful patent filings is

statistically insignificant. We also control for a large number of firm characteristics that

may potentially affect IPO long-run performance in a cross-sectional multivariate

regression framework. Our innovation proxy, a patent dummy, remains a strong positive

predictor of long-run abnormal returns.

The empirical results of this research suggest that investors do not fully comprehend

the information content in patents, possibly because of the difficulty of evaluating the

economic implications of such innovation information. This is especially relevant for

VC-backed IPOs with patents not widely cited, since such information is hard to access

or process. The results also suggest that for VC-backed IPOs, the ability to innovate is the

key driver of long-run performance. Innovation measures such as patents therefore have

important implications in the capital market.

31

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36

Table 1: Year distribution for VC-backed IPOs and successful patent filings

The sample consists of 2,511 venture capital (VC)-backed initial public offerings (IPOs) between

January 1981 and December 2006. The table reports the total number of VC-backed IPOs and

their successful patent filings over the five calendar years before or after the calendar year of the

IPO. The last two columns show the percentage of VC-backed IPOs among all VC-backed IPOs

that have successful patent filings over the five calendar years either before or after their IPOs.

The yearly successful patent filings from 1976 to 2005 are from the NBER patent dataset, which

contains information about all patents that were successfully granted by the USPTO from January

1, 1976 to December 31, 2006. There are no requirements that a firm has to continue to exist for a

full five-year window after the IPO. Successful patent filings after the IPO are measured until the

earlier of the end of event year +5 or the delisting date. Year 0 is the calendar year in which the

IPO occurred.

IPO

year

Number of

VC-backed

IPOs

Patent filings of

VC-backed IPOs

from -5 to -1 years

prior to the IPO

year

Patent filings of

VC-backed IPOs

from +1 to +5

years after the

IPO year

Percentage of VC-

backed IPOs having

patent filings from -5

to -1 years prior to

the IPO year

Percentage of VC-

backed IPOs having

new patent filings

from +1 to +5 years

after the IPO year

1981 54 49 122 31.5% 35.2%

1982 20 11 57 15.0% 25.0%

1983 116 290 931 33.6% 37.1%

1984 45 58 104 24.4% 26.7%

1985 37 5 40 10.8% 21.6%

1986 79 192 766 30.4% 34.2%

1987 67 88 446 26.9% 43.3%

1988 33 57 328 30.3% 42.4%

1989 39 107 337 38.5% 51.3%

1990 42 122 574 23.8% 31.0%

1991 116 197 1,658 33.6% 44.8%

1992 139 307 1,177 38.8% 45.3%

1993 172 405 2,188 36.6% 46.5%

1994 129 191 695 29.5% 43.4%

1995 188 491 1,624 31.9% 40.4%

1996 261 783 2,122 34.9% 44.4%

1997 132 408 1,697 37.1% 43.2%

1998 76 199 343 38.2% 43.4%

1999 271 800 1,776 33.6% 31.7%

2000 240 1,498 1,661 48.8% 43.8%

2001 32 179 - 59.4% -

2002 23 237 - 47.8% -

2003 24 282 - 37.5% -

2004 78 845 - 61.5% -

2005 45 273 - 46.7% -

2006 53 140 - 41.5% -

Total 2,511 8,214 18,646 36.3% 40.5%

37

Table 2: Mean values of financials for VC-backed IPOs without and with successful

patent filings The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006. Among them,

2,444 have financial information in COMPUSTAT for the fiscal year during which the IPO occurred. The

sample size falls to 1,390 five years after the IPO due to delistings. Panels A and B report the summary

statistics for, respectively, VC-backed IPOs without and with a successful patent filing, based on at least

one successful patent filings through the end of calendar year -3 relative to the calendar year in which the

IPO occurred. For example, an IPO in 1998 would be classified as with successful patents filings if at least

one successful filing occurred in 1995 or earlier. The firm characteristics include the following: equity

market capitalization, total assets, the ratio of book value‎to‎the‎market‎value‎of‎firm’s‎equity,‎the‎ratio‎of‎

operating income to assets, the ratio of net income to assets (ROA), the capital expenditures (CAPEX)-to-

assets ratio, the debt-to-assets ratio, the long-term debt-to-assets ratio, the R&D-to-assets ratio, and the

R&D-to-sales ratio. For all variables, fiscal year-end values reported in COMPUSTAT are used, which are

the values for the fiscal year in which the IPO occurred, and one to five fiscal years after the IPO. For

example, year +1 for Google, which went public on August 19, 2004 and which has a December 31 fiscal

year, ends on December 31, 2005. All accounting variables are winsorized at the 1% and 99% levels.

IPO year Year one Year two Year three Year four Year five

Panel A: VC-backed IPOs without successful patent filings from year -3 or earlier

Market value (millions of

dollars) 419 322 334 369 452 515

Assets (millions of dollars) 117 181 221 255 301 365

Book-to-market ratio 0.37 0.54 0.55 0.48 0.48 0.53

Operating income/assets -2.6% -7.5% -6.8% -4.4% -3.2% -2.1%

Net income/assets (ROA) -9.5% -20.8% -23.4% -18.3% -15.4% -13.9%

CAPEX/assets 7.4% 8.4% 6.8% 5.8% 5.5% 5.1%

Total debt/assets 10.6% 13.8% 15.5% 16.6% 16.2% 15.7%

Long-term debt/assets 8.1% 10.5% 11.4% 11.9% 12.0% 11.5%

R&D/assets 8.5% 12.0% 13.4% 13.9% 13.6% 12.9%

R&D/sales 0.46 0.48 0.46 0.37 0.34 0.33

Number of observations 1,813 1,677 1,462 1,272 1,110 962

Panel B: VC-backed IPOs with successful patent filings from year -3 or earlier

Market value (millions of

dollars) 367 327 355 424 564 587



Operating income/assets -5.4% -10.0% -12.4% -11.2% -9.9% -7.5%


CAPEX/assets 5.2% 6.2% 6.1% 5.3% 4.9% 4.8%



R&D/assets 14.4% 18.2% 20.3% 21.1% 20.0% 19.6%

R&D/sales 0.79 0.86 0.84 0.71 0.64 0.55

Number of observations 631 608 561 509 473 428

38

Table 3: Underpricing for VC-backed IPOs without and with successful patent

filings

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006.

“Without‎ patent‎ filings”‎ column‎ reports‎ the‎ underpricing‎ of‎ 1,874 VC-backed IPOs without

successful patent filings, and “With‎patent filings”‎column‎presents‎the‎underpricing‎of‎637 VC-

backed IPOs with successful patent filings, respectively, based on at least one successful patent

filing up to event year -3 or earlier prior to the calendar year in which the IPO occurred.

Underpricing is defined as the percentage first-day return, measured from the offer price to the

close.

IPO characteristics Without patent filings With patent filings

Average underpricing (equal weighted %) 29.0 27.1

Median underpricing (%) 10.8 9.5

Standard deviation (%) 56.8 52.2

Bubble period average** (equal weighted %) 92.4 94.2

Normal period average* (equal weighted %) 15.5 16.9

Percentage starting below offer price (%) 11.3 12.2

Average money left on the table ($ millions) 23.4 20.6

Number of issues 1,874 637

* Bubble period: September 1998 to June 2000.

** The normal period excludes the bubble period.

39

Table 4: Average raw and abnormal returns for VC-backed IPOs without and with

successful patent filings

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006. Panels

A and B report the average raw and abnormal returns of 1,874 VC-backed IPOs without

successful patent filings and 637 VC-backed IPOs with successful patent filings, respectively,

based on at least one successful patent filings up to year -3 or earlier prior to the IPO year. Panel

C reports the results for 4,568 non-VC-backed IPOs. The buy-and hold returns and monthly

returns are computed on the basis of monthly stock returns ending 24, 36, 48, and 60 calendar

months after the IPO and starting from the closing market price on the last trading day of the IPO

month. The buy-and-hold market-adjusted returns and monthly market-adjusted returns are

adjusted by the value-weighted (VW) NYSE/Amex/Nasdaq market index. Jensen alphas are the

intercepts estimated by running firm-specific time-series regressions of monthly firm excess

returns on the value-weighted NYSE/Amex/Nasdaq excess returns for 24, 36, 48, and 60 months

after the IPO. FF alphas are similar intercepts estimated using the Fama and French factors as

independent variables. FF-Investment alphas are the intercepts estimated using Fama-French &

Investment factors as independent variables. If the sample firm gets delisted, the IPO returns and

corresponding benchmark returns are calculated using data up to the delisting date. For example,

a portfolio with two IPOs that were listed for, respectively, 60 and 25 months would equally

weight the two buy-and-hold returns for the 60-month horizon, but the 60-month monthly average

raw return would be the average of 85 observations. When‎ available,‎ we‎ include‎ the‎ firm’s‎

delisting return. All stock return measures are expressed in percentages.

Holding

periods

after the

IPO

(month)

Buy-and-

hold raw

return (%)

Buy-and-

hold

market-

adjusted

return (%)

Monthly

raw return

(%)

Monthly

market-

adjusted

return (%)

Monthly

Jensen's

alpha (%)

Monthly FF

alpha (%)

Monthly

FF-

Investment

alpha (%)

Panel A: 1,874 VC-backed IPOs without successful patent filings from event year -3 or earlier

24 14.4 -10.2 -0.15 -1.09 -1.19 -0.57 -0.66

36 17.8 -20.1 -0.07 -0.99 -1.03 -0.44 -0.52

48 32.9 -19.9 0.15 -0.81 -0.92 -0.43 -0.50

60 39.1 -21.6 0.10 -0.83 -0.95 -0.45 -0.49

Panel B: 637 VC-backed IPOs with successful patent filings from event year -3 or earlier

24 25.9 3.5 0.84 0.01 -0.10 0.28 0.29

36 29.7 -5.0 0.97 0.15 0.05 0.49 0.51

48 45.2 -3.7 1.28 0.42 0.26 0.55 0.59

60 62.4 3.3 1.24 0.41 0.23 0.52 0.57

Panel C: 4,568 non-VC-backed IPOs

24 12.3 -17.3 0.22 -0.91 -0.97 -0.62 -0.66

36 19.0 -25.9 0.19 -0.93 -0.95 -0.64 -0.62

48 24.3 -35.0 0.17 -0.93 -0.94 -0.69 -0.68

60 29.7 -38.9 0.14 -0.92 -0.93 -0.72 -0.70

40

Table 5: Three-year performance for VC-backed IPOs without and with successful

patent filings sorted on non-high-tech, high-tech, and biotech industries

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006,

including 1,874 and 637 VC-backed IPOs without and with successful patent filings, respectively,

based on at least one successful patent filings up to year -3 or earlier before the calendar year in

which the IPO occurred (a minimum of 24 months and as many as 47 months before the IPO). We

further divide the sample firms into non-high-tech firms (825 without successful patent filings

and 264 with successful patent filings), high-tech firms (1,094 without successful patent filings

and 373 with successful patent filings), and biotech firms (154 without successful patent filings

and 102 with successful patent filings). The buy-and-hold returns and monthly returns are

computed on the basis of CRSP monthly stock returns over the 36 months starting from the end of

the IPO month. The buy-and-hold market-adjusted returns and monthly market-adjusted returns

are adjusted by the value-weighted (VW) NYSE/Amex/Nasdaq market index. Jensen alphas are

the intercepts estimated by running firm-specific time-series regressions of monthly firm excess

returns on the value-weighted NYSE/Amex/Nasdaq excess returns. FF alphas are similar

intercepts estimated using the Fama and French factors as independent variables. FF-Investment

alphas are the intercepts estimated using Fama-French & Investment factors as independent

variables. If the sample firm gets delisted, the IPO returns and corresponding benchmark returns

are calculated using data up to the delisting date. When available,‎we‎include‎the‎firm’s‎delisting‎

return. All of the raw and abnormal stock returns are the average of VC-backed IPOs within

group, and expressed in percentages.

Non-high-tech High-tech Biotech

Panel A: VC-backed IPOs without successful patent filings from event year -3 or earlier

Buy-and-hold 3-year raw return (%) 15.0 20.0 11.4

Buy-and-hold 3-year market-adjusted return (%) -26.9 -14.8 -29.0

Monthly market-adjusted return (%) -1.38 -0.68 -0.21

Monthly Jensen's alpha (%) -1.39 -0.74 -0.59

Monthly FF alpha (%) -0.99 -0.01 -0.09

Monthly FF-Investment alpha (%) -1.05 -0.09 -0.15

Number of observations 825 1,049 154

Panel B: VC-backed IPOs with successful patent filings from event year -3 or earlier

Buy-and-hold 3-year raw return (%) 12.0 42.2 15.7

Buy-and-hold 3-year market-adjusted return (%) -26.5 10.1 -12.6

Monthly market-adjusted return (%) -0.38 0.53 0.25

Monthly Jensen's alpha (%) -0.50 0.44 -0.03

Monthly FF alpha (%) -0.11 0.92 0.23

Monthly FF-Investment alpha (%) -0.09 0.94 0.12

Number of observations 264 373 102

41

Table 6: Three-year performance for VC-backed IPOs without and with successful

patent filings by subperiods

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006. Panels A and B

report the subperiod raw and abnormal stock returns of 1,874 and 637 VC-backed IPOs without and with

successful patent filings, respectively, based on at least one successful patent filings until event year -3 or

earlier prior to the calendar year in which the IPO occurred. Panel C reports the subperiod returns for all

2,511 VC-backed IPOs. Panel D reports the subperiod returns for 4,568 non-VC-backed IPOs. The full

sample is divided into four subsample periods: 1981 through 1989, 1990 through 1998, 1999 through 2000,

and 2001 through 2006. The buy-and hold returns and monthly returns are computed on the basis of

monthly stock returns ending 36 calendar months after the IPO and starting from the closing market price

on the last trading day of the IPO month. The buy-and-hold (BHR) market-adjusted returns and monthly

market-adjusted returns are adjusted by the value-weighted NYSE/Amex/Nasdaq market index. Jensen

alphas are the intercepts estimated by running firm-specific time-series regressions of monthly firm excess

returns on the value-weighted NYSE/Amex/Nasdaq excess returns. FF alphas are similar intercepts

estimated using Fama and French factors as independent variables. FF-Investment alphas are the intercepts

estimated using Fama-French & Investment factors as independent variables. If the sample firm gets

delisted, the IPO returns and corresponding benchmark returns are calculated using data up to the delisting

date.‎When‎available,‎we‎ include‎ the‎ firm’s‎delisting‎ return.‎ ‎All‎ stock‎ return‎measures‎are‎expressed‎ in‎

percentages.

Subperiod N

Buy-and-

hold 3-

year raw

return (%)

BHR 3-

year

market-

adjusted

return (%)

Monthly

raw return

(%)

Monthly

market-

adjusted

return (%)

Monthly

Jensen's

alpha (%)

Monthly

FF alpha

(%)

Monthly

FF-

Investment

alpha (%)


1981-1989 396 28.6 -17.4 -0.09 -1.28 -1.60 -0.90 -0.86

1990-1998 952 48.0 -13.4 1.11 -0.38 -0.99 0.02 -0.01

1999-2000 390 -68.7 -47.9 -3.21 -2.60 -0.90 -1.29 -1.64

2001-2006 136 22.9 4.9 0.73 0.24 0.03 0.07 0.16


1981-1989 94 31.2 -15.0 1.02 -0.16 -0.39 0.70 0.55

1990-1998 303 74.5 13.9 1.59 0.17 -0.32 0.60 0.65

1999-2000 121 -48.2 -23.8 0.18 0.82 2.13 1.20 1.18

2001-2006 119 -6.6 -26.2 0.17 -0.34 -0.76 -0.66 -0.56

Panel C: 2,511 VC-backed IPOs

1981-1989 490 29.1 -16.9 0.12 -1.06 -1.37 -0.60 -0.59

1990-1998 1,255 54.4 -6.9 1.22 -0.25 -0.83 0.16 0.15

1999-2000 511 -63.9 -42.2 -2.40 -1.79 -0.18 -0.80 -0.97

2001-2006 255 9.1 -9.6 0.47 -0.03 -0.34 -0.27 -0.18

Panel D: 4,568 Non-VC-backed IPOs

1981-1989 1,442 14.2 -30.9 0.19 -1.01 -1.09 -0.68 -0.63

1990-1998 2,343 29.7 -30.2 0.46 -0.99 -1.13 -0.68 -0.66

1999-2000 343 -40.5 -19.5 -1.69 -1.09 -0.09 -0.60 -0.59

2001-2006 440 23.6 7.7 0.19 -0.21 -0.22 -0.33 -0.41

42

Table 7: Three-year buy-and-hold performance for VC-backed IPOs without and with

successful patent filings by cohort year

The sample consists of 2,511 VC-backed IPOs from 1981 to 2006, including 1,874 and 637 VC-backed IPOs

without and with successful patent filings, respectively, based on at least one successful patent filing up to event

year -3 relative to the calendar year of the IPO. Panels A and B respectively report the equal- and value-weighted

buy-and-hold three-year returns and wealth relatives over the market index for VC-backed IPOs without and with

successful patent filings for each cohort year. For each cohort of IPOs that went public in a given calendar year, the

buy-and-hold returns are calculated by compounding monthly stock returns for 36 months from the last trading day

of the IPO month. If the sample firm gets delisted, the IPO returns and corresponding benchmark market returns are

calculated using data up to the delisting date. Wealth relatives are calculated as 𝑊𝑖,𝑇 = ∑(1 + 𝑅𝑖,𝑇)/ ∑(1 +

𝑅𝑏𝑒𝑛𝑐ℎ 𝑖,𝑇), where 𝑅𝑖,𝑇 is the buy-and-hold return on IPO i for holding period of length T (or shorter if there is an

early delisting) and 𝑅𝑏𝑒𝑛𝑐ℎ 𝑖,𝑇 is the buy-and-hold return on the value-weighted NYSE/Amex/Nasdaq market index

over the same period. The value weights are based on the market capitalization using the first-day closing prices in

CRSP, and are converted into dollars of 2006 purchasing power using the Consumer Price Index. For IPOs with

dual-class shares, we use shares outstanding reported by SDC. At the end of each panel, we report the corresponding

equal- or value-weighted average buy-and-hold three-year returns and wealth relatives over the entire 1981-2006

sample period.

VC-backed IPOs without patent filings VC-backed IPOs with patent filings

Number

of IPOs

IPO return

(%)

Market

return (%)

Wealth

relatives

Number of

IPOs

IPO return

(%)

Market

return (%)

Wealth

relatives

Panel A: Equal-weighted buy-and-hold returns

1981 40 8.2 38.8 0.78 14 20.7 38.6 0.87

1982 19 -12.7 72.4 0.51 1 83.8 66.3 1.11

1983 95 -2.7 53.9 0.63 21 29.6 60.7 0.81

1984 36 130.7 81.8 1.27 9 0.1 88.0 0.53

1985 34 -15.5 46.9 0.58 3 -11.2 44.9 0.61

1986 65 27.9 36.9 0.93 14 44.1 41.8 1.02

1987 51 0.9 20.0 0.84 16 16.7 22.3 0.95

1988 26 82.6 47.1 1.24 7 62.8 44.7 1.13

1989 30 110.9 33.1 1.58 9 72.2 31.5 1.31

1990 34 -1.7 50.5 0.65 8 207.9 45.0 2.12

1991 89 26.2 31.5 0.96 27 44.7 31.2 1.10

1992 96 20.1 35.8 0.88 43 83.4 37.7 1.33

1993 121 62.9 51.2 1.08 51 47.9 53.3 0.96

1994 102 105.7 82.6 1.13 27 178.5 86.4 1.49

1995 140 29.9 83.3 0.71 48 17.3 87.1 0.63

1996 211 27.5 81.5 0.70 50 2.7 85.3 0.55

1997 105 111.2 58.8 1.33 27 206.5 60.7 1.91

1998 54 26.4 15.9 1.09 22 104.9 18.5 1.73

1999 223 -61.2 -14.5 0.45 48 -20.7 -16.8 0.95

2000 167 -78.8 -29.2 0.30 73 -66.2 -29.3 0.48

2001 19 60.8 6.5 1.51 13 -33.8 2.3 0.65

2002 18 44.4 29.1 1.12 5 87.0 19.9 1.56

2003 15 94.1 46.3 1.33 9 -38.7 45.2 0.42

2004 33 10.2 44.4 0.76 45 19.9 43.0 0.84

2005 24 8.1 3.6 1.04 21 -16.0 12.7 0.75

2006 27 -28.8 -16.5 0.85 26 -38.2 -15.7 0.73

1981-2006 1,874 17.8 37.9 0.85 637 29.7 34.7 0.96

43

Panel B: Value-weighted buy-and-hold returns

1981 40 16.1 40.5 0.83 14 68.7 40.1 1.20

1982 19 -35.7 67.1 0.38 1 83.8 66.3 1.11

1983 95 -31.6 57.1 0.44 21 15.8 61.2 0.72

1984 36 1.3 80.4 0.56 9 17.7 86.2 0.63

1985 34 -12.9 46.6 0.59 3 -15.5 46.9 0.58

1986 65 86.2 37.3 1.36 14 40.3 37.9 1.02

1987 51 -1.6 21.2 0.81 16 4.8 21.6 0.86

1988 26 86.1 44.9 1.28 7 63.2 45.4 1.12

1989 30 77.5 33.6 1.33 9 72.1 29.6 1.33

1990 34 -11.7 50.3 0.59 8 390.9 44.5 3.40

1991 89 31.5 31.6 1.00 27 51.5 30.9 1.16

1992 96 41.9 35.6 1.05 43 70.8 35.8 1.26

1993 121 53.6 52.2 1.01 51 42.4 53.7 0.93

1994 102 128.5 84.8 1.24 27 227.5 88.9 1.73

1995 140 31.4 81.4 0.72 48 -13.0 81.4 0.48

1996 211 78.4 81.9 0.98 50 5.6 87.9 0.56

1997 105 202.2 57.7 1.92 27 306.7 72.0 2.36

1998 54 121.9 17.0 1.90 22 14.6 16.4 0.99

1999 223 -79.8 -17.4 0.24 48 -64.9 -22.5 0.45

2000 167 -88.6 -30.6 0.16 73 -76.7 -30.4 0.33

2001 19 69.8 6.7 1.59 13 -47.2 -1.2 0.53

2002 18 34.1 19.6 1.12 5 78.2 20.5 1.48

2003 15 71.3 45.7 1.18 9 -32.6 45.4 0.46

2004 33 21.1 39.6 0.87 45 268.9 46.8 2.51

2005 24 56.1 1.9 1.53 21 -22.8 11.3 0.69

2006 27 -42.1 -19.4 0.72 26 -45.5 -15.2 0.64

1981-2006 1,874 -29.9 4.7 0.67 637 23.0 11.6 1.10

44

Table 8: Time-series regressions for calendar-time portfolios of VC-backed IPOs

without and with successful patent filings, and non-VC-backed IPOs

We form the equal- and value-weighted monthly calendar-time portfolios of VC-backed IPOs

without (N=1,874 IPOs) and with (N=637) successful patent filings as well as non VC-backed

IPOs (N=4,568) by including all issues that were undertaken in the three years previous to the

month of the observation. VC-backed IPOs with and without successful patent filings are based

on at least one successful patent applications up to event year -3 or earlier relative to the IPO

calendar year. The calendar-time portfolios are rebalanced every month, and the value weights are

based‎on‎the‎previous‎month’s‎month-end market values of the issuing firms. RMRF is the value

weighted market return on all NYSE/AMEX/ Nasdaq firms (RM) minus the risk free rate (RF)

which is the one-month Treasury bill rate. SMB is the difference each month between the return

on small firms and big firms. HML is the difference each month between the return on a portfolio

of high book-to-market stocks and the return on a portfolio of low book-to-market stocks. IAH is

the difference each month between the return on a portfolio of stocks with high R&D and high

innovation ability and the return on a portfolio of stocks with high R&D and low innovation

ability as in Cohen, Diether, and Malloy (2012). The sample period covers the 347 months

between February 1981 and December 2009. White (1980) robust t-statistics are reported in

parentheses.

VC-backed IPOs without

successful patent filings

VC-backed IPOs with

successful patent filings Non-VC backed IPOs

Equal-

weighted

Value-

weighted

Equal-

weighted

Value-

weighted

Equal-

weighted

Value-

weighted

Panel A: Fama-French factors

Alpha -0.17%

(-0.75)

0.22%

(0.80)

0.55%

(2.39)

0.90%

(2.68)

-0.66%

(-3.88)

-0.08%

(-0.63)

RMRF 1.36

(21.65)

1.40

(17.75)

1.21

(17.67)

1.33

(14.45)

1.23

(27.14)

1.17

(40.07)

SMB 1.14

(7.07)

0.87

(6.81)

1.46

(14.79)

1.16

(9.18)

0.96

(9.15)

0.56

(13.57)

HML -0.71

(-6.97)

-1.14

(-9.40)

-0.89

(-10.55)

-1.21

(-9.75)

-0.02

(-0.37)

-0.31

(-6.09)

R2 0.83 0.80

0.83 0.75 0.83 0.89

Panel B: Fama-French and innovation ability factors

Alpha -0.12%

(-0.55)

0.24%

(0.89)

0.58%

(2.42)

0.86%

(2.59)

-0.61%

(-3.54)

-0.09%

(-0.76)

RMRF 1.36

(22.15)

1.40

(17.93)

1.20

(17.79)

1.33

(14.26)

1.23

(27.12)

1.17

(40.29)

SMB 1.14

(7.17)

0.87

(6.85)

1.46

(14.87)

1.17

(9.19)

0.95

(9.45)

0.56

(13.39)

HML -0.73

(-7.22)

-1.14

(-9.57)

-0.90

(-10.62)

-1.20

(-9.51)

-0.04

(-0.42)

-0.31

(-5.91)

IAH -0.04

(-1.12)

-0.02

(-0.57)

-0.02

(-0.74)

0.03

(0.74)

-0.04

(-2.02)

0.01

(0.88)

R2 0.83 0.80 0.83 0.75 0.84 0.89

45

Table 9: Multivariate regression analyses for VC-backed IPOs

The sample consists of 2,511 VC-IPOs between January 1981 and December 2006. The

dependent variable for (1) to (3) is the buy-and-hold 3-year market-adjusted return adjusted by

the value-weighted NYSE/Amex/Nasdaq market index. The dependent variable for (4) to (6) is

the monthly Fama-French alpha estimated by running firm-specific time-series regressions of

monthly firm excess returns on the Fama and French factors for 36 months after the IPO. If the

sample firm gets delisted, the IPO returns and corresponding benchmark returns are calculated

using data up to the delisting date. We include a patent dummy equal to one when the firm has at

least one successful patent filing up to the end of event year -3 relative to the IPO year. The

sample size falls to 2,280 when we include financial control variables: the logarithm of inflation-

adjusted sales (in millions of 2006 dollars),‎Tobin’s‎Q,‎underpricing,‎the‎debt-to-total assets ratio,

the research and development expenses-to-sales ratio, and the patent filings-to-R&D expenses

ratio. All the financial variables are computed using data at the end of the fiscal year of the IPO in

COMPUSTAT. We also control for the logarithm of firm age at the IPO and underwriter

reputation (measured on a 0 to 9 scale, with 9 high). Underpricing and the accounting ratios are

measured as fractions. All the regressions control for industry and year fixed effects. A constant is

always included in regressions although not reported. Below each regression coefficient, t-

statistics are reported in the parentheses with the standard errors of the regression coefficients

clustered at the industry and year levels. *, **, and *** indicate significance at the 10%, 5%, and

1% confidence level, respectively.

Buy-and-hold 3-year market-adjusted

return (%) Monthly Fama-French alpha (%)

(1) (2) (3) (4) (5) (6)

Patent dummy 24.0**

(2.42)

20.6**

(2.30)

24.2***

(2.72)

0.88***

(3.17)

0.77***

(3.15)

0.75***

(3.06)

Log(Sales) 19.5***

(4.72)

18.6***

(5.24)

0.58***

(5.22)

0.59***

(3.22)

Tobin's Q -0.00

(-1.40)

-0.01***

(-5.34)

-0.001

(-1.31)

-0.001

(-1.34)

Underpricing -4.05

(-0.41)

-6.61

(-0.79)

-0.28

(-1.44)

-0.32*

(-1.83)

Debt/assets -10.6

(-0.26)

-4.94

(-0.11)

-3.46***

(-3.95)

-3.30***

(-3.93)

R&D/sales 7.59

(1.39)

5.02

(0.84)

0.31*

(1.67)

0.22

(1.47)

Patent filings/R&D 3.23*

(1.73)

2.89

(1.49)

0.14**

(2.10)

0.14*

(2.15)

Log(1+firm age at IPO) -24.0

(-1.45)

-0.004

(-0.02)

Underwriter reputation 4.12

(0.71)

0.21*

(1.90)

Number of observations 2,511 2,280 2,280 2,511 2,280 2,280

R2 0.049 0.073 0.079 0.073 0.097 0.106

Year fixed effects Yes Yes Yes Yes Yes Yes

Industry fixed effects Yes Yes Yes Yes Yes Yes

46

Figure 1: Average number of successful patent filings per firm per event year for

VC-backed IPOs before and after the IPO

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006, 637 of

which have successful patent filings, based on at least one successful patent filing until the end of

event year -3 or earlier, where event year 0 is the calendar year in which the IPO occurred. The

solid line reports the annual average number of new successful patent filings per firm per event

year over [-5, +5] event years relative to the calendar year of IPO for all the 2,511 VC-backed

IPOs; the dashed line depicts the annual average number of new successful patent filings per firm

per event year for the subset of 637 VC-backed IPOs with successful patent filings, based on one

or more successful patent filings up to event year -3 before the IPO calendar year. There are 2,511

firms for event years -5 to -1, which decreases to 1,591 at event year +5. There are no

requirements that a firm has to continue to exist for a full five-year window after the IPO. If a

company is delisted after the IPO, the successful patent filings counts stop for this company in the

delisting year and subsequent years, and the average number of successful patent filings is

calculated based on the surviving firms. Successful patent filings are calculated until the earlier of

the event year +5 after the IPO, the delisting date, or December of 2005.

47

Internet Appendix for

“Patent and Innovation-Driven Performance in

Venture Capital-Backed IPOs”

Table A1: List of successful patent filings for some VC-backed IPOs in NBER

database and patent information in the IPO prospectus

Panel A: Patent information in NBER database and IPO prospectus

NBER successful patent filings before the

IPO IPO prospectus

Firm name IPO Date -5 -4 -3 -2 -1 0 Patents

Granted

Patent

Filings

Google 20040819 0 10 6 1 10 2 No details No details

Marvell

Technology 20000626 1 2 11 5 0 0 9 9

Priceline.com 19990329 0 0 0 10 2 2 2 25

Sandisk 19951107 0 1 0 3 7 19 58 20

Silicon Image 19991005 0 1 5 4 7 9 4 17

Panel B: Patent descriptions in IPO prospectus

Firm name Patent descriptions in IPO prospectus

Google The first version of the PageRank technology was created while Larry and Sergey attended

Stanford University, which owns a patent to PageRank. The PageRank patent expires in 2017.

We hold a perpetual license to this patent. In October 2003, we extended our exclusivity period

to this patent through 2011, at which point our license is non-exclusive.

Marvell

Technology

As of February 29, 2000, we had been granted nine United States patents on various aspects of

our technology, with expiration dates ranging from 2015 to 2018, and we had filed nine

additional United States patent applications. However, there can be no assurance that patents

will ever be issued for these applications.

Priceline.com We currently hold one issued United States patent directed to a unique Internet-based buyer-

driven commerce method and system underlying our business model. We also hold one issued

United States patent directed to a method and system for pricing and selling airline ticket options

and one issued United States patent directed to methods and systems for generating airline-

specified time tickets. In addition, we have pending 25 United States and four international

patent applications directed to different aspects of our technology and business processes.

Sandisk The Company currently owns or has exclusive rights to fifty-eight United States and fourteen

foreign issued patents, six patent applications allowed and over twenty patent applications

pending in the United States, as well as seventeen pending in foreign patent offices.

Silicon Image Our success and future revenue growth will depend, in part, on our ability to protect our

intellectual property. We rely on a combination of patent, copyright, trademark and trade secret

laws, as well as nondisclosure agreements and other methods to protect our proprietary

technologies. We have been issued four United States patents. We have filed 17 additional

United States patent applications. Three of these 17 applications have been allowed by the U.S.

Patent and Trademark Office.

48

Table A2: Average raw and abnormal returns for VC-backed IPOs without and with

successful patent filings up to event year -2

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006. Panels

A and B report the average raw and abnormal returns of 1,723 VC-backed IPOs without

successful patent filings and 788 VC-backed IPOs with successful patent filings, respectively,

based on at least one successful patent filings up to event year -2 or earlier prior to the IPO. In

Table 4, the classification of VC-backed IPOs with and without patents is based on year -3. This

table reclassifies 135 IPOs from unsuccessful to successful. The buy-and hold returns and

monthly returns are computed on the basis of monthly stock returns ending 24, 36, 48, and 60

calendar months after the IPO and starting from the closing market price on the last trading day of

the IPO month. The buy-and-hold market-adjusted returns and monthly market-adjusted returns

are adjusted by the value-weighted (VW) NYSE/Amex/Nasdaq market index. Jensen alphas are

the intercepts estimated by running firm-specific time-series regressions of monthly firm excess

returns on the value-weighted NYSE/Amex/Nasdaq excess returns for 24, 36, 48, and 60 months

after the IPO. FF alphas are similar intercepts estimated using Fama and French factors as

independent variables. FF-Investment alphas are the intercepts estimated using Fama-French &

Investment factors as independent variables. If the sample firm gets delisted, the IPO returns and

corresponding benchmark returns are calculated using data up to the delisting date. When

available,‎ we‎ include‎ the‎ firm’s‎ delisting‎ return.‎ ‎ All‎ stock‎ return‎ measures‎ are‎ expressed‎ in‎

percentages.

Holding

periods

after the

IPO

(month)

Buy-and-

hold raw

return (%)

Buy-and-

hold

market-

adjusted

return (%)

Monthly

raw return

(%)

Monthly

market-

adjusted

return (%)

Monthly

Jensen's

alpha (%)

Monthly FF

alpha (%)

Monthly

FF-

Investment

alpha (%)


24 13.9 -11.1 -0.19 -1.15 -1.25 -0.65 -0.76

36 14.5 -23.7 -0.13 -1.06 -1.10 -0.52 -0.60

48 27.1 -26.4 0.08 -0.89 -1.00 -0.51 -0.59

60 40.0 -23.9 0.03 -0.93 -1.06 -0.55 -0.58


24 24.8 2.8 0.73 -0.08 -0.17 0.29 0.30

36 34.6 0.0 0.89 0.08 0.01 0.49 0.49

48 55.5 7.4 1.22 0.37 0.22 0.54 0.56

60 56.0 -1.2 1.17 0.36 0.18 0.51 0.54

49

Table A3: Means of financials for VC-backed IPOs without and with successful

patent filings sorted on size and book-to-market ratio

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006. Among them, 2,444

have financial information in COMPUSTAT at the fiscal year during which the IPO occurred. Panels A and B

report the summary statistics for VC-backed IPOs without and with successful patent filings, respectively, based

on at least one successful patent filings through the end of the event year -3 or earlier prior to the IPO year. For

each cohort of IPOs issued in a given calendar year, firms are sorted into three size groups (“Small”,‎“Medium”,‎

and‎“Large”)‎and‎ three book-to-market‎ ratio‎groups‎ (“Growth”,‎“Medium”,‎and‎“Value”)‎based‎on‎ the‎market‎

value at the first closing price listed by the CRSP and book value of equity at the IPO fiscal year from the

COMPUSTAT. For IPOs with dual-class shares, we use shares outstanding reported by SDC. Both size

breakpoints and Book-to-market ratio breakpoints are the same for the VC-backed IPOs with and without

successful patent filings in each year. The firm characteristics include the following: equity market capitalization,

total assets, the ratio of book value to the market‎value‎of‎firm’s‎equity,‎the‎ratio‎of‎operating‎income‎to‎assets,‎

the ratio of net income to assets (ROA), the capital expenditures (CAPEX)-to-assets ratio, the debt-to-assets ratio,

the long-term debt-to-assets ratio, the R&D-to-assets ratio, and the R&D-to-sales ratio. All the variables are

measured at the end of the fiscal year during which the IPO occurred using data from COMPUSTAT.

Size Terciles Book-to-Market Terciles

Small Medium Large Growth Medium Value

Panel A: VC-backed IPOs without successful patent filings from event year -3 or earlier

Market value (millions of dollars) 117 293 867 591 321 335



Operating income/assets -6.2% -0.8% -0.7% -9.5% -3.9% 5.4%


CAPEX/assets 7.1% 7.4% 7.8% 7.9% 6.9% 7.4%



R&D/assets 9.8% 8.5% 7.2% 11.4% 9.0% 5.2%

R&D/sales 0.57 0.47 0.34 0.53 0.57 0.29


Panel B: VC-backed IPOs with successful patent filings from event year -3 or earlier

Market value (millions of dollars) 154 275 726 541 242 343



Operating income/assets -11.2% -4.9% 0.9% -11.0% -7.2% 2.9%


CAPEX/assets 4.5% 5.1% 6.2% 5.6% 4.9% 5.2%



R&D/assets 16.7% 14.4% 11.4% 16.4% 14.9% 11.6%

R&D/sales 0.90 0.82 0.64 0.81 0.91 0.64


50

Table A4: Three-year performance for VC-backed IPOs without and with successful

patent filings sorted on size and book-to-market ratio

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006. Panels A

and B report the raw and abnormal returns of 1,874 VC-backed IPOs without successful patent filings

and 637 VC-backed IPOs with successful patent filings, respectively, based on at least one successful

patent filings up to event year -3 or earlier prior to the IPO. For each cohort of IPOs issued in a given

calendar year, firms are sorted into three size groups (“Small”,‎ “Medium”,‎ and‎ “Large”)‎ and three

book-to-market‎ ratio‎ groups‎ (“Growth”,‎ “Medium”,‎ and‎ “Value”)‎ based‎ on‎ the‎market‎ value‎ at‎ the‎

first closing price listed by the CRSP and book value of equity at IPO fiscal year from the

COMPUSTAT. For IPOs with dual-class shares, we use shares outstanding reported by SDC. Both

size breakpoints and Book-to-market ratio breakpoints are the same for the VC-backed IPOs with and

without successful patent filings. The buy-and hold returns and monthly returns are computed on the

basis of monthly stock returns ending 36 calendar months after the IPO and starting from the closing

market price on the last trading day of the IPO month. The buy-and-hold market-adjusted returns and

monthly market-adjusted returns are adjusted by the value-weighted (VW) NYSE/Amex/Nasdaq

market index. Jensen alphas are the intercepts estimated by running firm-specific time-series

regressions of monthly firm excess returns on the value-weighted NYSE/Amex/Nasdaq excess returns.

FF alphas are similar intercepts estimated using Fama and French factors as independent variables.

FF-Investment alphas are the intercepts estimated using Fama-French & Investment factors as

independent variables. If the sample firm gets delisted, the IPO returns and corresponding benchmark

returns‎ are‎ calculated‎ using‎ data‎ up‎ to‎ the‎ delisting‎ date.‎ When‎ available,‎ we‎ include‎ the‎ firm’s‎

delisting return. All of the raw and abnormal stock returns are the average of VC-backed IPOs within

group, and expressed in percentages.

Size terciles Book-to-market terciles

Small Medium Large Growth Medium Value

Panel A: VC-backed IPOs without successful patent filings

Buy-and-hold 3-year raw return

(%) 10.0 9.8 35.1 14.4 8.3 31.3

Buy-and-hold 3-year market-

adjusted return (%) -30.0 -27.9 -1.0 -22.1 -30.3 -8.7

Monthly market-adjusted return

(%) -1.13 -0.81 -1.07 -1.47 -0.81 -0.64

Monthly Jensen's alpha (%) -1.11 -0.91 -1.09 -1.51 -0.90 -0.59

Monthly FF alpha (%) -0.69 -0.32 -0.35 -0.70 -0.37 -0.03

Monthly FF-Investment alpha (%) -0.97 -0.31 -0.33 -0.80 -0.50 -0.05


Panel B: VC-backed IPOs with successful patent filings

Buy-and-hold 3-year raw return

(%) 17.9 17.3 60.8 20.5 17.2 49.8

Buy-and-hold 3-year market-

adjusted return (%) -15.3 -16.5 23.1 -14.8 -18.0 16.5

Monthly market-adjusted return

(%) 0.25 0.05 0.20 -0.39 -0.24 0.93

Monthly Jensen's alpha (%) 0.30 0.06 -0.25 -0.46 -0.26 0.87

Monthly FF alpha (%) 0.57 0.48 0.43 0.03 0.19 1.26

Monthly FF-Investment alpha (%) 0.58 0.47 0.49 -0.10 0.19 1.41


51

Table A5: Fama-French-adjusted performance for calendar-time portfolios of VC-

backed IPO with successful patent filings sorted on Citations

The sample consists of 637 VC-backed IPOs with successful patent filings based on at least one

successful patent application up to event year -3 or earlier prior to the IPO from January 1981

through December 2006. Among them, 435 firms have citation data. We form the monthly

citation calendar-time portfolios of VC-backed IPOs with successful patent filings by including

all issues that were undertaken in the three years previous to the month of the observation. The

portfolios are rebalanced monthly and VC-backed IPOs are allowed to switch portfolios every

half year. We form portfolios according to citation information up to the event year -1 before the

IPO year: Panel A divides firms into a portfolio below median number of citation counts and

another above median number of citation counts; Panel B divides the firms into a portfolio

without citation and a portfolio with citation;. Both equal- and value-weighted calendar-time

portfolios are constructed and the value weights are based‎on‎previous‎month’s‎market‎values‎of‎

the firms. RMRF is the value weighted market return on all NYSE/AMEX/ Nasdaq firms (RM)

minus the risk free rate (RF) which is the one-month Treasury bill rate. SMB is the difference

each month between the return on small firms and big firms. HML is the difference each month

between the return on a portfolio of high book-to-market stocks and the return on a portfolio of

low book-to-market stocks. The analysis extends between January 1981 and December 2009.

White (1980) robust t-statistics are reported in parentheses.

Panel A: Low citation (N=217) vs. High citation (N=218)

Equal-weighted Value-weighted

Low citation High citation Low citation High citation

Alpha 0.90%

(3.16)

0.27%

(0.73)

1.35%

(3.11)

-0.05%

(-0.12)

RMRF 1.11

(13.92)

1.21

(11.20)

1.26

(12.70)

1.24

(10.86)

SMB 1.42

(9.63)

1.52

(10.58)

1.02

(5.50)

1.44

(7.10)

HML -1.03

(-7.39)

-1.08

(-8.19)

-1.40

(-7.36)

-1.33

(-7.40)

R2 0.74 0.69 0.60 0.66

Panel B: Without citation (N=75) vs. With citation (N=360)

Equal-weighted Value-weighted

Without citation With citation Without citation With citation

Alpha 1.35%

(2.42)

0.74%

(2.77)

1.52%

(2.33)

0.90%

(2.55)

RMRF 1.42

(11.01)

1.10

(14.05)

1.48

(10.56)

1.16

(12.38)

SMB 1.18

(5.84)

1.52

(11.53)

0.96

(3.38)

1.34

(7.39)

HML -1.29

(-5.91)

-1.08

(-9.10)

-1.58

(-5.77)

-1.31

(-8.45)

R2 0.53 0.79 0.48 0.71

52

Table A6: Fama-French-adjusted performance for calendar-time portfolios of VC-

backed IPOs without and with successful patent filings sorted on size and book-to-

market ratio

The sample consists of 2,511 VC-backed IPOs between January 1981 and December 2006, including

1,874 VC-backed IPOs without successful patent filings and 637 VC-backed IPOs with successful

patent filings based on at least one successful patent applications up to event year -3 or earlier prior to

the IPO. In Panels A and B, we form the monthly size calendar-time portfolios of VC-backed IPOs

without and with successful patent filings by including all issues that were undertaken in the three

years previous to the month of the observation. Following Brav and Gompers (1997), we allocate

equal‎number‎of‎firms‎into‎three‎size‎portfolios‎(“Small”,‎“Medium”,‎and‎“Large”)‎every‎six‎months‎

based on the previous month's size distribution using all VC-backed IPOs. In Panels C and D, we form

the monthly book-to-market portfolios of VC-backed IPOs without and with successful patent filings

by including all issues that were undertaken in the three years previous to the month of the observation.

Every six months we divide the sample into three book-to-market‎portfolios‎ (“Growth”,‎“Medium”,‎

and‎ “Value”)‎ based‎ on‎ the‎ previous‎month's‎ book-to-market ratio distribution using all VC-backed

IPOs. The portfolios are rebalanced monthly and VC-backed IPOs are allowed to switch portfolios

every six months. Both equal- and value-weighted size and book-to-market portfolios are constructed

and‎the‎value‎weights‎are‎based‎on‎previous‎month’s‎market‎values‎of‎the‎firms.‎RMRF‎is‎the‎value‎

weighted market return on all NYSE/AMEX/ Nasdaq firms (RM) minus the risk free rate (RF) which

is the one-month Treasury bill rate. SMB is the difference each month between the return on small

firms and big firms. HML is the difference each month between the return on a portfolio of high book-

to-market stocks and the return on a portfolio of low book-to-market stocks. The analysis extends

between January 1981 and December 2009. White (1980) robust t-statistics are reported in parentheses.

Equal-weighted size terciles Value-weighted size terciles

Small Medium Large Small Medium Large

Panel A: VC-backed IPOs without successful patent filings

Alpha -0.20%

(-0.55)

-0.34%

(-1.36)

0.10%

(0.38)

-0.63%

(-1.85)

-0.50%

(-2.03)

0.46%

(1.44)

RMRF 1.31

(14.03)

1.41

(18.67)

1.35

(20.22)

1.40

(13.81)

1.37

(18.36)

1.41

(15.49)

SMB 1.18

(5.55)

1.21

(7.55)

0.86

(5.81)

1.19

(5.66)

1.13

(7.35)

0.63

(5.27)

HML -0.33

(-2.12)

-0.73

(-6.45)

-1.10

(-9.97)

-0.31

(-2.13)

-0.78

(-6.95)

-1.36

(-9.61)

R2 0.62 0.82 0.80 0.57 0.77 0.63

Panel B: VC-backed IPOs with successful patent filings

Alpha 0.31%

(0.70)

0.25%

(0.86)

1.23%

(3.64)

-0.42%

(-1.02)

0.07%

(0.22)

1.39%

(3.07)

RMRF 1.10

(8.65)

1.28

(15.93)

1.23

(11.95)

1.05

(8.09)

1.28

(14.92)

1.37

(11.10)

SMB 1.61

(8.77)

1.45

(13.92)

1.28

(9.25)

1.55

(10.40)

1.38

(12.25)

0.99

(6.01)

HML -0.51

(-2.64)

-0.81

(-6.22)

-1.38

(-9.36)

-0.56

(-3.18)

-0.93

(-6.51)

-1.45

(-8.50)

R2 0.53 0.79 0.74 0.57 0.77 0.63

53

Equal-weighted book-to-market

terciles

Value-weighted book-to-market

terciles

Growth Medium Value Growth Medium Value

Panel C: VC-backed IPOs without successful patent filings

Alpha -1.25%

(-4.29)

-0.38%

(-1.55)

1.40%

(4.50)

-0.21%

(-0.66)

-0.33%

(-1.27)

1.32%

(4.24)

RMRF 1.48

(15.96)

1.37

(17.82)

1.30

(16.02)

1.45

(15.97)

1.34

(16.28)

1.46

(14.50)

SMB 1.03

(6.47)

1.14

(6.77)

1.16

(6.59)

0.81

(5.48)

0.96

(7.74)

1.23

(9.73)

HML -0.91

(-6.47)

-0.74

(-6.07)

-0.42

(-3.28)

-1.34

(-9.84)

-0.98

(-7.43)

-0.37

(-2.29)

R2 0.77 0.80 0.69 0.64 0.79 0.58

Panel D: VC-backed IPOs with successful patent filings

Alpha -0.35%

(-0.99)

0.21%

(0.72)

1.90%

(4.39)

0.32%

(0.78)

0.15%

(0.50)

2.59%

(5.16)

RMRF 1.18

(12.20)

1.35

(14.53)

1.15

(9.71)

1.20

(10.18)

1.34

(15.13)

1.32

(10.78)

SMB 1.18

(10.97)

1.41

(13.24)

1.71

(8.55)

1.11

(5.96)

1.36

(13.17)

1.52

(6.89)

HML -1.10

(-8.38)

-0.74

(-6.13)

-0.81

(-4.63)

-1.37

(-7.68)

-1.01

(-8.28)

-1.12

(-5.41)

R2 0.68 0.78 0.60 0.64 0.79 0.58

Date post:	22-Sep-2020
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