Innovate to survive: The effect
of technology competition on
corporate bankruptcy
Assaf Eisdorfer
Po-Hsuan (Paul) Hsu
Department of Finance
School of Business
University of Connecticut
NUS RMI
June 2009
A recent article on BusinessWeek observes:
Among 2,700 company respondents, their
innovation investment will not fall much in 2009
2
Another recent article on Wall Street Journal
observes:
“Wary of emerging from the recession
with obsolete products, 28 big U.S.
companies spent nearly as much on
R&D in the dismal 2008Q4 as they did
a year earlier, even as their revenue
fell 7.7%.”
“Big R&D spenders say they've
learned from past downturns that they
must invest through tough times if
they hope to compete when the
economy improves.”
“Companies realize that large
reductions in R&D are suicidal.”
“It is the last shoe to drop.”
3
Motivation:
￭ The finance literature has a long history in analyzing
bankruptcy since Altman (1968):
Development of bankruptcy prediction models
Assessment of bankruptcy costs
Relation between bankruptcy to macroeconomic conditions
￭ However…
Previous studies addressing bankruptcies mainly focus on
accounting- and financial information
To our knowledge, no study has examined how technological
innovations and competition impact corporate bankruptcies
- Are they related?
Po-Hsuan (Paul) Hsu
4
Related literature: Innovations in general and
bankruptcies
￭ “Creative destruction” – Schumpeter (1942):
The economy grows as new technologies destroy old technologies
￭ Technological innovations, competition, and firm values:
- Greenwood and Jovanovic (1999) and Hobijn and Jovanovic
(2001) argue that the IT technology wave deteriorates the value of
old incapable firms and raises the value of new growth firms
- Garleanu, Kogan, and Panageas (2009) suggest that
technological innovations intensify the product market competition
and lower the profits and market values of all existing firms
￭ Technological innovations and stock returns:
- Griliches (1984), Pakes (1985) find that higher R&D bring up
productivity and stock returns
- Hsu (2009) finds patent shocks and R&D shocks raise market
returns and premiums Po-Hsuan (Paul) Hsu
5
Related literature: Patents and bankruptcies
￭ The improvement in patent protection makes the relation between
technology competition and bankruptcy even more direct
￭ Patents become new, widely used weapons:
- Hall (2004): Patent competition becomes fierce in the mid 80s
due to (1) the establishment of a patent-specialized court (the
Court of Appeals for the Federal Circuit, CAFC) in 1982 and (2) a
few publicized patent infringement cases in the mid 80s
- Bessen and Meurer (2005) find that the annual number of total
patent lawsuits doubles over the period 1984 to 1999
￭ Patent disputes and litigations are very costly:
All costs including legal expenditures, loss from preliminary
injunction, and loss of reputation make the defendant firm hard to
survive the litigation process (Bhagat, Brickley, and Coles, 1994;
Lerner, 1995; Lanjouw and Lerner, 2001)
Po-Hsuan (Paul) Hsu
6
One recent example:
￭ Vonage (VG in NYSE):
- A Voice-over-Internet Protocol (VoIP) provider which has been sued
for patent infringement by many competitors
- In its 2008 annual report , the firm reports that “In addition, we have
been subject to other infringement claims in the past and, given the
rapid technological change in our industry and our continual
development of new products and services, we may be subject to
infringement claims in the future.”
- In the same report, it confirms that the patent litigations “could lead
to bankruptcy or liquidation of the company.”
Po-Hsuan (Paul) Hsu
7
Main testable implications:
￭ H1: A firm’s technology competition measures contain information
about bankruptcy likelihood over conventional bankruptcy models
- Financial and accounting measures do not necessarily capture the
technology competition status
- Yet, this status could be a dominant factor, especially in hitech
industries
￭ H2: Bankruptcies related to technology competition are less sensitive
to overall market- and industry-wide conditions
- Technological innovations are good for economy/industry growth
but bad for current existing firms
￭ H3: Technology-related bankruptcies are more costly (indirect costs)
- Demand fall, higher depreciation, bad reputation, and potential
litigation costs
Po-Hsuan (Paul) Hsu
8
Data
￭ Bankruptcy data:
- Although CRSP has a specific code for bankruptcy, we include all
the delisting categories associated with poor performance such as
‘liquidation’ and ‘dropping due to bad performances’ in the
bankruptcy group
- Total 3,034 bankrupt cases in 1976-2005
￭ U.S. patent data:
- Patent Full-Text and Image Data (PatFT) of the U.S. Patent and
Trademark Office (USPTO) database
- There are 5,024 firms (about 25% of public firms) with 1,099,434
successful patent applications and 998,272 patent issues in 19762005
- Annual counts of all patents (utility, design, plant, and reissue)
assigned to each firm according to their application dates or issue
dates
Po-Hsuan (Paul) Hsu
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Data (continued)
￭ Advantages of patent data
- Unlike R&D expenditures, patents are realized technologies of
business value
- Patents draw competition because they are proprietary and
exclusive
- Firms realized the necessity of defensive patent filings (Hall, 2004;
Hall and Ziedonis, 2007)
- Patents are a powerful tool to hinder competitors or create income
from loyalties (Lerner, 1995)
￭ Technology-intensive industries
- All industries (by 4-digit SIC codes) have at least 25% of firms
applying for patents every year
- Total 62 industries including aircraft, computers, semiconductors,
and biological and pharmaceutical industries
- 30.4% of total market cap
Po-Hsuan (Paul) Hsu
10
Descriptive statistics
Table 2
Technology-intensive industries
(market cap = 30.4%)
Mean
Median
StdD
Other industries
(market cap = 69.6%)
Mean
Median
StdD
# applications per firm in a year
15.25
0.00
59.65
1.87
0.00
21.24
# issues per firm in a year
14.23
0.00
57.33
1.75
0.00
20.82
% firms apply for patents in a year
32.95
0.00
47.00
7.17
0.00
25.79
% firms issue patents in a year
31.16
0.00
46.32
6.65
0.00
24.91
101.02 9,503.16
974.13
63.16
7,585.40
Size
1,731.67
Market-to-book
2.88
1.91
2.99
2.32
1.51
2.55
Book leverage
0.20
0.17
0.18
0.25
0.23
0.21
R&D investment
0.10
0.05
0.14
0.03
0.00
0.08
Z-score
4.33
3.46
3.64
3.70
3.07
3.19
KMV measure
0.11
0.02
0.19
0.13
0.03
0.21
Po-Hsuan (Paul) Hsu
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￭ H1a (aggregate level): The increase in total new patents reflects more
severe technology competition overall, which leads to higher
bankruptcy likelihood
Bankruptcy freqt ,t 3   0  1# Patentst   2 Interestt   3 Default t   4 Re cessiont   t
Table 3 Panel A: Time series regression
Tech. intensive
industries
All industries
Coefficient
P-value
Coefficient
P-value
Intercept
Δ # patents
0.06312
(0.336)
0.01115
(0.012)
0.09074
(0.879)
0.01045
(0.015)
0.08654
(0.000)
0.00942
(0.015)
0.11954
(0.000)
0.00836
(0.037)
Po-Hsuan (Paul) Hsu
Interest
Default
Recession R-square
0.187
-0.08354
(0.690)
-2.34366
(0.206)
0.02798
(0.029)
0.384
0.165
0.09210
(0.781)
-3.72838
(0.213)
0.02333
(0.229)
0.285
12
The time series relation between bankruptcy frequency and
changes of new patents
4,000
0.14
Change in total number of patents (lef t axis)
Bankruptcy f requency (right axis)
3,000
0.12
2,000
0.1
1,000
0.08
0
0.06
‐1,000
0.04
‐2,000
0.02
‐3,000
0
1975
1980
1985
1990
Po-Hsuan (Paul) Hsu
1995
2000
2005
13
￭ H1b (Individual firm): Individual firms are more likely to go bankrupt if (i)
they fall farther behind their competitors in patent competition, and
(ii) the patent activity in the industry is more intense
(1) Firm PT-RD: firm patents / industry patents – firm R&D / industry R&D
(2) Ind.PI: Industry patents / Industry size
Bankruptcy indicatori ,( t ,t  3)   0  1 Firm PT  RDi ,t   2 Ind . PI i ,t
  3 Z scorei ,t   4Credit rating i ,t   5 KMVi ,t   i ,t
Table 5 Panel A: Logit regression
Coefficient
P-value
Intercept
Firm PT-RD
Ind. PI
-3.00410
(0.000)
-0.68420
(0.000)
3.18080
(0.000)
-4.84060
(0.000)
-1.00710
(0.000)
2.74880
(0.0370)
-3.64260
(0.000)
-0.93840
(0.000)
3.31390
(0.000)
Po-Hsuan (Paul) Hsu
Z-score Credit rating
KMV
-0.00912
(0.000)
# Obs
30,454
1.92620
(0.000)
4,834
2.34690
(0.000)
10,422
14
The economic significance of the predictive ability
We inspect the marginal increase of bankruptcy probability with respect
to one standard deviation increase of explanatory factors
10.81%!
12%
10%
4.03%
8%
2.47%
3.02%
2.74%
1.69%
1.16%
6%
4%
6.78%
6.78%
6.78%
6.78%
6.78%
6.78%
6.78%
Sample
frequency
Firm PT-RD
Industry PI
Firm PT-RD
+Industry PI
Z-score
Credit rating
KMV
2%
0%
￭ 4% is about the default probability spread between AAA and B bonds
￭ The bankruptcy probability of FDIC’s watch list for banks is about 13%
15
￭ H2a (Business cycle): Technology-related bankruptcies are less
affected by the business cycle
￭ RC = NBER recession indicator: 1 or 0
￭ PDI = 1 for patent-intensive industries, and 0 otherwise
￭ Pct Ap = Average % of firms in the industry that apply for patents
during a calendar year
- PDI and Pct Ap are two measures of industry-specific competition in
technology
Table 6 Panel A: Industry-level pooled regression (# Obs=12,707)
Bankruptcy freq.
Intercept
RC
RC*PDI
Intercept
RC
RC*Pct Ap
Coefficient
P-value
0.02522
(0.000)
0.00978
(0.000)
-0.01079
(0.023)
0.02522
(0.000)
0.01066
(0.000)
-0.02372
(0.056)
Table 6 Panel B: Firm-level logit regression (# Obs=190,507)
Bankruptcy indicator
Intercept
RC
RC*PDI
Intercept
RC
RC*Pct Ap
Coefficient
P-value
-3.77470
(0.000)
0.44660
(0.000)
-0.27010
(0.011)
-3.77470
(0.000)
0.40970
(0.000)
-0.00877
(0.975)
Po-Hsuan (Paul) Hsu
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￭ H2b (Industry growth): Technology-related bankruptcies are less
affected by the industry growth
￭ IG = Annual percentage change in the total revenues in the industry
minus the market-wide change
￭ Again, PDI and Pct Ap are two measures of industry-specific
competition in technology
Table 7 Panel A: Industry-level pooled regression (# Obs=12,295)
Bankruptcy freq.
Intercept
IG
IG*PDI
Intercept
IG
IG*Pct Ap
Coefficient
P-value
0.02588
(0.000)
-0.02138
(0.000)
0.01874
(0.026)
0.02589
(0.000)
-0.02175
(0.000)
0.02715
(0.331)
Table 7 Panel B: Firm-level logit regression (# Obs=188,178)
Bankruptcy indicator
Intercept
IG
IG*PDI
Intercept
IG
IG*Pct Ap
Coefficient
P-value
-3.69680
(0.000)
-0.75120
(0.000)
0.75890
(0.001)
-3.69500
(0.000)
-0.81890
(0.000)
1.83120
(0.004)
Po-Hsuan (Paul) Hsu
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￭ H3a (indirect bankruptcy costs): Technology-related bankruptcies
incur higher indirect bankruptcy costs
￭ Technology-related bankruptcies: firms that went bankrupt without
receiving any patent during the three years prior to bankruptcy in
technology-intensive industries
￭ Two measures of indirect bankruptcy costs:
- Abnormal earnings in 3 years prior to bankruptcy (Altman, 1984)
- Cumulative stock returns in 3 years prior to bankruptcy
Table 8
Technology-related
bankruptcies
Abnormal
earnings
Stock returns
Ordinary
bankruptcies
P-value of
difference
# Obs
Mean
Median # Obs
Mean
Median
Means Medians
Raw data
57
-0.281
-0.256
481
-0.172
-0.162
(0.178)
(0.069)
Ind. adjusted
57
-0.236
-0.189
486
-0.124
-0.098
(0.141)
(0.067)
Raw data
279
-0.499
-0.764
2,755
-0.431
-0.714
(0.089)
(0.028)
Ind. adjusted
278
-0.572
-0.627
2,757
-0.444
-0.472
(0.003)
(0.000)
Po-Hsuan (Paul) Hsu
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￭ H3b (sensitivity to competition): Indirect bankruptcy costs are
positively correlated with technology competition
￭ We now focus on technology-related bankruptcies and regress the
indirect bankruptcy costs on technology competition measures
Table 9 Panel A: Abnormal earnings
Coefficient
P-value
Intercept
Pct Ap
-0.14856
(0.000)
-0.27352
(0.048)
-0.08263
(0.268)
-0.26833
(0.051)
Size
M/B
Leverage
# Obs
R-square
457
0.009
-0.01253
(0.075)
-0.00557
(0.503)
0.21112
(0.001)
457
0.043
Size
M/B
Leverage
# Obs
R-square
2,879
0.006
2,879
0.076
Table 9 Panel B: Stock returns
Coefficient
P-value
Intercept
Pct Ap
-0.36126
(0.000)
-0.56782
(0.000)
0.44318
(0.000)
-0.44839
(0.001)
-0.06570
(0.000)
-0.05087
(0.000)
Po-Hsuan (Paul) Hsu
-0.11409
(0.040)
19
Concerns about patent litigation addressed in
annual/quarterly reports of technology-related bankruptcies
￭ Sample: 279 technology-related bankruptcies (76-05)
￭ Some concerns: No assurance that third parties’ patents will not adversely affect the
Company.
￭ Significant concerns: If we are accused of infringing the intellectual property rights of
other parties we may become subject to time-consuming and costly litigation.
Po-Hsuan (Paul) Hsu
20
Conclusions
￭ This paper proposes and empirically establishes a strong relation
between technology competition and corporate bankruptcy
￭ Using the data set of firm-level patent applications and issues, we
show the follows:
(1) The competence in technology-intensive industries predicts future
bankruptcies better than well-used measures such as Z-score,
credit rating, and KMV measure
(2) Technology-related bankruptcies are less related to macroeconomic
conditions such as business cycles and industry growth
(3) Technology-related bankruptcies are significantly more costly than
ordinary ones
Po-Hsuan (Paul) Hsu
21
Ongoing and future related topics
￭ Inspecting the role of technological innovations in asset
pricing and corporate finance
- Innovation geography and stock returns
- Innovations and idiosyncratic risk
￭ Large-scale multiple tests for predictability and data
snooping correction
- The time-varying predictability/profitability in foreign exchanges
Po-Hsuan (Paul) Hsu
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￭ H1b (industry level): The increase in industry patents reflects more
severe technology competition within the industry, which leads to
more bankruptcies among the firms incapable of generating
patents
Bankruptcy freq *i ,(t ,t 3)   0  1 # Patentsi ,t   2 Z i ,t
  3 Spec. Rating i ,t   4 KMVi ,t   i ,t
Table 4 Panel A: Pooled regression
Coefficient
P-value
Intercept
# patents
0.05760
(0.000)
0.22350
(0.000)
0.06683
(0.000)
0.05341
(0.000)
0.15944
(0.048)
Z
Spec. ratio
KMV
# Obs
R-square
1,812
0.018
-0.00351
(0.007)
0.01834
(0.197)
0.25039
(0.000)
474
0.075
-0.00389
(0.004)
0.01684
(0.226)
0.22832
(0.000)
474
0.086
Po-Hsuan (Paul) Hsu
23
Page Title:
￭ A benchmark for bankruptcy watch list – the FDIC watch
list






Only 13 percent of banks on watch list fail: FDIC's Bair
Mon Jul 28, 2008 7:33pm EDT
WASHINGTON (Reuters) - About 13 percent of banks placed on a
regulatory watch list historically have failed, the head of the U.S.
Federal Deposit Insurance Corp said on Monday.
The agency has a running tally of problem banks that its examiners
closely monitor. At the end of the first quarter, 90 institutions were
on the list that is expected to be updated next month.
"Actually, only 13 percent of the institutions that go on the troubled
bank list eventually fail," FDIC Chairman Sheila Bair said in an
interview on the PBS program "NewsHour with Jim Lehrer."
"We work with the primary regulator to give them extra care and
attention, to nurse them back to health or to sell them off to another
24
institution," said Bair. Po-Hsuan (Paul) Hsu
Page Title:
￭ Claims of infringement:
If we are accused of infringing the intellectual property rights of other
parties we may become subject to time-consuming and costly
litigation. If we lose such litigation, we could suffer a significant
impact on our business and be forced to pay damages. Third
parties may assert that our products infringe their proprietary rights,
or may assert claims for indemnification resulting from infringement
claims against us. Any such claims may cause us to delay or
cancel shipment of our products or pay damages, which could
seriously harm our business, financial condition and results of
operations
Po-Hsuan (Paul) Hsu
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Injunctions in patent infringement cases:




One of the remedies available to a patent owner ("plaintiff") in the
United States against an alleged infringer ("defendant") of the patent
is an injunction to prevent future infringement by the defendant. The
availability of an injunction is a powerful right of the plaintiff that can
be granted by the federal district court judge who is hearing the case.
In general, there are two types of injunctions available in a patentinfringement lawsuit.
The first is a preliminary injunction, which, as its name implies, is
granted very early in a court action for patent infringement and
restrains the defendant from infringing the patent during the
pendency of litigation. In the event the plaintiff wins at trial, the
preliminary injunction most likely will be converted into a permanent
injunction.
In many cases, the issuance of a preliminary injunction effectively
ends the matter for all practical purposes between the parties, as this
is a crippling blow to the defendant.
26
Po-Hsuan (Paul) Hsu
Comparing my patent data set to the NBER one
(1) NBER dataset ends in 1999, which is already 10-year
old, and my dataset can be easily updated anytime I
want;
(2) its frequency is mainly yearly, while my dataset can be
monthly, quarterly, or annual.
(3) The NBER patents are assigned Cusip identifiers using
the 1989 ownership structure of the patent holder
(4) NBER patent data set does not go to very details like the
city of assignees
Po-Hsuan (Paul) Hsu
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Page Title:
￭

Po-Hsuan (Paul) Hsu
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