Litigation and Cost of Debt

Principal Investigator:
Bo Wang

Abstract:
In this paper, I investigate whether and to what extent patent litigation would influence the cost of debt. Data is collected from multiple sources. I have performed manual name matches among databases to construct the sample (Kafouros et al., 2021, among others). The research question I examine in the project is how patent litigation affects the pricing of loans and bonds and the non-pricing terms of debt. I will use multiple advanced regressions to reduce potential endogeneity concerns. Further, I will explore contingency effects that help to understand the potential underlying channel and mechanism.

Description of Research:
Lawsuits involving patents increased significantly in the past decades (Bessen et al., 2018). Firms use patent litigation to protect their intellectual property rights because patents are among the most valuable intangible assets that firms have to generate profits. Previous literature identified that involvement in patent litigation might influence firms’ innovation outcome (Mezzanotti 2021, among others), financial performance (Schliessler 2015), and regional entrepreneurial activity (Kiebzak et al. 2016). It is still less known how patent litigation may affect the firm’s ability to obtain debt financing. On the one hand, patent litigation would be costly to the defendant (Agarwal et al., 2009). Most defendants are involved in patent litigation involuntarily. Therefore, they need to allocate a certain amount of human and financial capital to deal with the lawsuits, which later reduces the capital and time that could have been used in the operation, capital budgeting, and other innovative projects. Consequently, involvement in litigation influences firms’ operations and financial constraints (Mezzanotti 2021). Firms would then face a raised cost of borrowing after the litigation. On the other hand, the defendant’s response to the litigation and not settling with the plaintiff could unintentionally signal the value of the patents (Horner et al., 2022). Potential creditors and lenders may consider those patents profitable and increase their value as collateral to acquire new capital (Mann 2018). Following this logic, the defendants would enjoy a favorable cost of debt after the litigation. Therefore, it asks for an empirical investigation on which force is dominant over the other.

The potential contribution of this paper is multifold. First, this project continues my research interest in innovation and helps to shed new light on how the protection mechanism of intellectual property will affect the cost of financing and capital structure for corporations. Second, this paper investigates whether patent litigation would signal the patent value and help reduce the information asymmetry between the borrowers and the lenders. Finally, our sample help isolates the influence of patent litigation from other types of litigations and provides a unique opportunity to identify the patent litigation effects.