Abstract
We investigate the stock returns for acquirers of firms holding registered patents (“innovative targets”). We find that acquiring innovative targets is associated with significantly positive stock performance relative to acquisitions of non-innovative targets. Specifically, acquirers of innovative targets enjoy higher announcement and interim period abnormal returns. Acquirers of innovative targets also enjoy higher post-acquisition returns, but only in settings where the acquirer’s and target’s industry is unambiguously close (i.e., they share the same 3-digit primary SIC code), suggesting that when the acquirer has familiarity and expertise in that industry the acquirer is able to better exploit the target firm’s patents. Additionally, we find that an acquirer’s innovation level can be critical to their post-acquisition stock performance; that is, acquirers holding at least one patent of their own prior to the acquisition enjoy significantly higher post-acquisition returns, and this benefit does not depend on the innovativeness of the target firm.
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Notes
The main determinant of bonus payments and compensation increases to executives is net income (Murphy 1999, 2012). Because R&D reduces earnings, it creates disincentives for managers to invest in these projects (Duru et al. 2002). In addition, executives are constantly pressured to meet earnings benchmarks. Graham et al. (2005) shows survey evidence suggesting that managers curtail R&D and other discretionary spending items to meet earnings expectations. Hence, the incentives not to invest in “organic” innovation are strong.
Our measure of industry relatedness is admittedly crude (see Alhenawi and Stilwell 2018), but is suitable for our purpose of identifying settings where acquirer managers have sufficient experience to exploit the target’s patents.
Another possible disadvantage of buying an innovative target could be that the acquirer may overpay. Moeller et al. (2004) find that larger firms tend to overpay for targets, and firms may also pay an additional premium for the patents of the target firm. We also investigate this possibility.
Our announcement period returns are measured as of days − 2 to + 2 relative to the acquisition announcement, and our interim returns are measured as of day + 3 relative to the announcement date until the acquisition effective date. Our post-acquisition period begins on the day of acquisition effective date and ends 2 years after.
Sevilir and Tian (2012) do show results for three models: a market model, a 3-factor model, and a 4-factor model. They find significant results for only their 4-factor model. Our results suggest significant post-acquisition returns are only realized when the acquirer and innovative target share the same 3-digit primary SIC code.
In contrast, Fong et al (2019) report that greater cultural distance between the acquirer and target results in higher post-acquisition returns enjoyed by the acquirer.
This is an ubiquitous quote; one reference is found at http://www.personal.psu.edu/mrr18/blogs/psel/2012/06/innovation-distinguishes-between-a-leader-and-a-follower—steve-jobs.html.
Kogan et al. (2017) collect details of patents data from google through a special data-hosting arrangement with United States Patent and Trademark Office (USPTO). They download high-quality text files and then extract information from the text files. We appreciate Leonid Kogan, Dimitris Papanikolaou, Amit Seru, and Noah Stoffman for sharing the patent dataset (available at: https://iu.app.box.com/v/patents).
Our calculation follows the recommendations of Barber and Lyon (1997). Lyon et al. (1999) suggest that the use of control firms may have slightly less power than alternative methodologies (which works against our finding of significant results), although their specification tests suggest that it performs approximately as well as other methodologies.
In our calculation of returns, we include delisting returns for any firm delisted before the end of the post-acquisition period; we follow Beaver et al. (2007) by using average delisting returns for firms in the same industry when the delisting returns for a particular firm are missing.
We check our results with two other proxies for innovative target. First, we place target firms into ranks from 0 to 4 based on the number of patents they hold (“innovative target rank”). Second, we calculate the average of the cumulative abnormal returns (CAR) around the date when each target patent was announced (“target innovation level rank”). Our conclusions remain the same.
Using a fully interacted model (i.e., also including the following interactions in model (2): Industry Expertise*Innovative AQ and Innovative Target*Industry Expertise*Innovative AQ) causes undue multicollinearity (e.g., the variance inflation factors (VIF) associated with some interaction variables exceeded 12), which leads to loss of significance in some of our variables of interest. We note that the direction and magnitude of the coefficients of interest remained relatively unchanged.
The average of the number of patents is 1517 highlighting the skewness of the distribution of patents.
Our results hold with our other two innovative target proxies noted in footnote 10. Specifically, “innovative target rank” and “target innovation level rank.”
Our number of observations are only 2882 for interim period returns (vs. 3542 for the announcement and post-acquisition returns) because 996 announced acquisitions were also consummated on the same day, leaving no interim period.
Overpayment may be less likely here because the target’s patents are explicitly documented innovations that may be easier to evaluate (and value) than other “synergies” that are often less rigorously identified (see Sirower 1997).
Because we use both acquirers and non-acquirers in our prediction model, we didn’t label the variables as “AQ XX”. We calculate them as we explain in Appendix for both acquirer firms and non-acquirer firms.
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Appendix
Appendix
Variable definitions and calculations
Variable name | Description |
|---|---|
INNOVATIVE TARGET | Indicator variable set to 1 if the firm acquirers a target that had at least one registered patent (pre-acquisition), and 0 otherwise |
LOG(NUMBER OF PATENTS) | The natural log of one plus the number of patents held by the target firm |
INDUSTRY EXPERTISE | Indicator variable set to 1 if the acquirer and target share the same 3-digit SIC code, 0 otherwise |
INNOVATIVE AQ | Indicator variable set to 1 if the acquirer had at least one registered patent, 0 otherwise |
DEAL PREMIUM | Total dollar value of consideration by the acquirer divided by the pre-announcement market capitalization of the target firm |
CASH AQ | Indicator variable set to 1 if the acquirer offers only cash as consideration for the acquisition, 0 otherwise |
STOCK CONSIDERATION | Indicator variable set to 1 if the acquirer offers only its own voting stock as consideration for the acquisition, 0 otherwise |
HOSTILE ACQUISITION | Indicator variable set to 1 if the deal was resisted by target management (as reported by SDC), 0 otherwise |
LOG OF AQ MARKET CAP. | Acquirer market cap is measured as of the most recent month-end at least 30 days before the acquisition announcement |
PRE-ANNOUNCEMENT AQ CASH | Acquirer cash and short-term investments (CHE), scaled by total assets (AT) |
AQ NOA | NOA is defined following Nissim and Penman (2001, appendix), as: \({\text{Net}}\;{\text{Financial}}\;{\text{Obligations}}\; \, \left( {\text{NFO}} \right)\;{\text{plus}}\;{\text{Common}}\;{\text{Equity}}\;\left( {\text{CSE}} \right)\;{\text{plus}}\;{\text{Minority}}\;{\text{Interest}}\;\left( {\text{MI}} \right),\) where NFO = Financial Obligations (FO) less Financial Assets (FA) FO = debit in current liabilities (DLC) + total long-term debt (DLTT) + preferred stock (PSTK) − preferred stock in treasury (TSTKP) + preferred dividends in arrears (DVPA) FA = cash and short-term investments (CHE) + other investments and advances (IVAO) CSE = common equity (CEQ) + preferred stock in treasury (TSTKP) − preferred dividends in arrears (DVPA) MI = minority interest (MIB) Simplifying, NOA is calculated as DLC + DLTT + PSTK − CHE − IVAO + CEQ + MIB We scale NOA by lagged total assets (AT). To avoid losing observations unnecessarily, we replace missing values for DLC, DLTT, PSTK, IVAO, and MIB with zeros |
AQ LEVERAGE | Long-term debt plus long-term debt due in 1 year, divided by total assets |
AQ ACCRUALS | Total Accruals are defined following Richardson et al. (2005), as: \({\text{TACC}} =\Delta {\text{WC }} +\Delta {\text{NCO}} +\Delta {\text{FIN}},\) where ∆ = change from prior year to current year WC = working capital = current operating assets (COA) less current operating liabilities (COL) COA = current assets (ACT) − cash and short-term investments (CHE) COL = current liabilities (LCT) − debt in current liabilities (DLC) NCO = non-current operating assets (NCOA) − non-current operating liabilities (NCOL) NCOA = total assets (AT) − current assets (ACT) − other investments and advances (IVAO) NCOL = total liabilities (LT) − current liabilities (ACT) − long-term debt (DLTT) FIN = financial assets (FA) − financial liabilities (FL) FA = short-term investments (IVST) + other investments and advances (IVAO) FL = long-term debt (DLTT) + debt in current liabilities (DLC) + preferred stock (PSTK) Simplifying, accruals are calculated as ∆AT − ∆CHE − ∆LT + ∆IVST − ∆PSTK, scaled by lagged total assets (AT) To avoid losing observations unnecessarily, we replace missing values for PSTK, LT, and RECTA with zeros |
AQ SALES GROWTH | Current year sales (SALE) less prior year sales, divided by prior year sales |
AQ R&D EXPENSES | Research and Development expense divided by total sales. If it is missing, it replaces as 0 |
ALTMAN’S Z SCORE | The summary measure of bankruptcy created by Altman (1968), calculated as: (0.012*((current assets − current liabilities)/total assets)) + (0.014*(retained earnings/total assets)) +(0.033* ((pretax income + interest expense)/total assets)) + (0.006*(mcap/total liabilities)) + (0.999*(#12/total assets)) |
AQ BOOK-TO-MARKET | Total book value of common equity (CEQ) divided by market capitalization |
AQ MOMENTUM | Buy-and-hold acquirer returns, accumulated from month − 12 to the closest month-end at least 30 days before the announcement of the acquisition |
DEAL PREMIUM | Total dollar value of consideration by the acquirer divided by the pre-announcement market capitalization of the target firm |
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Kim, K.H., Oler, D.K. & Sanchez, J.M. Examining the stock performance of acquirers where the acquirer or target hold patents. Rev Quant Finan Acc 56, 185–217 (2021). https://doi.org/10.1007/s11156-020-00890-0
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DOI: https://doi.org/10.1007/s11156-020-00890-0