Jim Moore’s blog: Innovation, Strategy, Public Policy

To the editor,

I am writing regarding this New York Times article, on patents.

This article conveys the surprising “finding” that for public companies in the United States, patent litigation costs are apparently much higher than previous researchers have documented.  Boston University researchers Bresson and Mauer claim that “Domestic litigation costs alone, meanwhile, soared to $16 billion in 1999 from $8 billion in 1997.”

Is this true? Really? Unfortunately the writer, Michael Fitzgerald, neglects to point out the key assumption that underlies the Bresson and Mauer studies.

Though the arguments are complex, at core the authors assume that the “cost of litigation” is best estimated by the reaction of investors upon reading about the filing of a patent suit in the Wall Street Journal.

Stated more generally, the authors’ argue that if investors discount a stock in response to the announcement of patent litigation, the decline in market cap of the company can be assumed to be a sound estimate of the projected “litigation cost” of the suit. This argument assumes market rationality and the wisdom of crowds to an extreme seldom contemplated by serious analyists of markets.

I kid you not. Here is the astounding argument in the authors’ words:

SSRN-The Private Costs of Patent Litigation by James Bessen, Michael Meurer

Here is the relevant passage:

A key assumption of this literature is that the change in firm value that occurs around a

lawsuit filing reflects investors’ estimates of the direct and indirect effects of the lawsuit on the

profits of the firm and not any unrelated information. We argue below that this is a plausible

assumption for defendants in infringement suits and that, therefore, we may associate the loss in

wealth with the effective total cost of litigation for defendants.

We find that firms lose about half a percentage point of their stock market value upon

being sued for patent infringement. This corresponds to a mean cost of $28.7 million in 1992

dollars (median of $2.9 million), much larger than mean legal fees of about half a million. In

aggregate, infringement risk rose sharply during the late 1990s, reaching 19% of R&D spending.

The authors calculate the cost of patent litigation based principally ON THE AVERAGE DROP IN MARKET CAP OF PUBLIC COMPANIES WHEN A LAWSUIT IS FILED AGAINST THEM. THIS DROP AVERAGES ABOUT 1%. Stock market value for most companies are highly sensitive to perceived negative announcements, and a negative movement of 1% is hardly ever significant or lasting. For investors, trend is usually more meaningful than the sensitivity to perceived events.

Of course, a 1% drop, if assumed to be “real” and more or less irreversable, yields very large dollar amounts for the “cost of patent litigation.”

Most of us, on reading about the cost of patent litigation, would assume this refers to legal fees. However, the authors’ note that in their model the “direct costs of legal fees” are much less than what they argue is the total cost of being accused of patent infringement.

These estimates are clearly much larger than the estimates of direct legal costs. Most of

the cost of litigation to firms appears to arise from business costs such as loss of market share,

management distraction, and increased financial costs from greater risk.

Of course, this is broadly true. But is it right then to estimate this broader cost based on small fluctuations in market value? I think not.

So what is the bottom line? James Bessen and Michael Meurer are taking on the patent system, and promoting their upcoming book.

Would I bet on their academic careers? Sure. In the current climate in academics, and in tech journalism, one can ride “patent reform” pretty far.

Would I ask them to help me invest? No. Would I take their strategic advice on patent strategy? No. Would I rely on them to set policy for innovation in the United States? No.