Patent trolls create a chilling effect that deters R&D investment.

A higher probability of being sued increases the expected legal and settlement costs for atrisk technology peers. However, this is not the only reason for their market value losses. The other source of market value loss is that at-risk technology peers might respond to higher NPE litigation risk by increasing R&D investments in “workaround technologies” that could adversely affect these firms’ operational performance. To identify the impact of NPEs lawsuits on at-risk technology peers’ R&D investments, we analyze at-risk technology peers who are not sued by NPEs in the previous or following five years for patent infringement related to the same patent class when a defendant is sued by an NPE (i.e., non-litigated peers). As these firms do not incur lawsuits, we are able to avoid the confounding effect on the changes in R&D investments due to higher legal and settlement costs, as documented by Cohen et al. (2016, 2019).

We first show that such non-litigated peers nevertheless incur an average CAR of -1.1% in the [-1, +1] three-day window when a defendant is sued by an NPE, suggesting that these firms ex ante still face a significant probability of being sued. Interestingly, we find that non-litigated peers exhibit significant increases in R&D activities in the five-year period following an NPE case filing. Thus, non-litigated peers behave opposite to the defendants who have to cut R&D due to higher legal costs (Cohen et al. 2016, 2019). The increase in R&D activities of non-litigated peers, however, is in line with the the survey by Chien (2014), which finds a “chilling effect” of NPE lawsuits in that at-risk firms not yet sued take actions to lower the likelihood of subsequent NPE lawsuits. It is also consistent with the game theory predictions of Reitzig, Henkel, and Heath (2007) and Henkel and Reitz (2010) that a non-litigated peer may react by proactively replacing the NPE’s technology with a non-infringing alternative (i.e., “workaround technology”).2

Workaround technologies could be either strategic technologies that are mainly for litigation purposes but have less value, or intrinsic technologies that provide long-term value to firms (Abrams, Akcigit, and Popadak 2013; Mezzanotti 2021). To differentiate these two types of innovation outcomes, we investigate the values and impacts of the patents generated from nonlitigated peers’ R&D investments. We document for non-litigated peers a decline in the ratio of patent citations to R&D and the ratio of patent values to R&D in the five-year period following an NPE lawsuit filing, i.e., fewer patent citations as well as lower patent values for each dollar of R&D spending, suggesting that increased R&D investments likely concentrate on strategic technologies. Given the reduction in the values of R&D investments, it is conceivable that these firms could also suffer higher operational risk and lower profitability. Indeed, we find that nonlitigated peers report significant reductions in returns on assets (ROA) and cash flows from operations in the five-year period following an NPE lawsuit filing. These reductions are again more pronounced than those following a PE lawsuit filing.