Bereskin Et Al-2018-SSRN Electronic Journal

So Sue Me!
Patent Litigation and the Cross-section of Stock Returns‡
Fred Bereskin*, Po-Hsuan Hsu**, William Latham***, Huijun Wang†
December 1, 2018
Abstract: Using comprehensive patent lawsuit data from 2000 to 2014, we find that a stock
portfolio consisting of firms involved in patent lawsuits as either plaintiffs or defendants
provides significantly positive returns and risk-adjusted alphas (between 0.56% to 1.02% per
month) in the following year. We propose and examine several possible explanations for this
pattern, including industry heterogeneity, unknown or unspecified systematic risk, financial
constraints, cash-driven lawsuits, and undervaluation of the benefits associated with patent
litigation. Further evidence based on firms’ future profitability and competition, as well as
information delay, suggests that the positive association between patent litigation and stock
returns can be attributed to investors’ undervaluation of potential benefits related to patent
litigation.
Keywords: Patent litigation; stock returns; information delay; underpricing
JEL classification: G12, G14, O34
‡ We thank Dan Bereskin, Jim Bessen, Lauren Cohen, Jarrad Harford, Edwin Lai, Haitian Lu, Don MacOdrum,
Michael Meurer, Zhenjiang Qin, Avri Ravid, Ghon Rhee, Ryan Whalen, Angela Zhang, and Shu Zhang, as well as
seminar participants at the 2018 FMA Conference, University of Hong Kong (School of Law), University of
Massachusetts Lowell, and the Taiwan Finance Association Annual Meeting for their valuable comments. We also
thank Brian Howard from Lex Machina for preparing and organizing data for us.
* Trulaske College of Business, University of Missouri, Columbia MO 65211. Email: bereskinf@missouri.edu.
Phone: 573-884-9709.
** Faculty of Business and Economics, University of Hong Kong, Pokfulam Road, Hong Kong. Email:
paulhsu@hku.hk. Phone: +852-2859-1049.
*** Lerner College of Business & Economics, University of Delaware, Newark, DE 19716.
Email: latham@udel.edu. Phone: (302) 831-6846.
† Lerner College of Business & Economics, University of Delaware, Newark, DE 19716. Email: wangh@udel.edu.
Phone: (302) 831-7087.
Electronic copy available at: https://ssrn.com/abstract=3090551

1. Introduction
Patent litigation is an important issue for firms, managers, and shareholders in today’s
business environment where intellectual property plays a critical role. Compared to the 1980s
and earlier, firms are now more likely to be involved in patent litigation, either as plaintiffs or
defendants (United States Government Accountability Office, 2013). It is commonly perceived
that the more litigious environment has increased firms’ risk of being exposed to significant
direct and indirect litigation costs, which may retard their exploitation of intellectual property
and reduce their long-term growth.1 Whether patent litigation has any asset pricing implication
and explains the variation in future stock returns, however, has not been well-studied in the
finance literature.
To fill this void in the literature, we first collect patent lawsuits involving public firms
from the Lex Machina database, which covers patent litigation cases filed since 2000. The Lex
Machina database is regarded as the most comprehensive database of U.S. patent lawsuits and
has been used in many recent studies (Akcigit, Celik, and Greenwood, 2016; Allison, Lemley,
and Schwartz, 2015, 2018; Cohen, Gurun, and Kominers, 2016b, 2018). We then combine the
patent litigation data with the CRSP/Compustat database to examine the cross-sectional variation
in the stock returns of firms’ being involved in patent litigations (either as plaintiffs or
defendants) in patent lawsuits between 2000 and 2014.
We then adopt a calendar-time portfolio approach and create a monthly-rebalanced stock

portfolio consisting of firms experiencing patent litigation in the past 12 months (“litigation
portfolio” henceforth), and find that this portfolio generates excess returns as high as 1.02% per
month in the 2000-2014 period. We use the court filing records and dates to identify firms
involved in patent litigation, either as plaintiffs or defendants in lawsuit cases involving patents
1
For example, the American Intellectual Property Law Association (2015) reports that patent litigation tends to be
costly and time-intensive. Specifically, the median patent infringement suit experiences litigation costs ranging from
$100,000 (when less than $1 million is at risk) to $5 million (when more than $25 million is at risk); additionally,
amounts at risk are associated with greater hours required to litigate. Aside from these direct costs, we also note
potential indirect costs including reduced pledgeability (Chava, Nanda, and Xiao, 2017; Mann, 2018) or the reduced
selling price of intellectual property (Lev, 2001). Akcigit, Celik, and Greenwood (2016) note that 20% of domestic
patents are sold. Other indirect costs include distractions to management, difficulties in ensuring long-run
commitments with suppliers and customers (Tucker, 2014), difficulties in attracting financing (Feldman, 2014), and
delays in implementing innovation and marketing strategies.

that are filed in court.2 Unlike the event-time portfolio approach that pools all events together
regardless timing, this calendar-time portfolio approach is a practical trading strategy that can
deliver trading profits (if any) to investors and thus has asset pricing implications.3 Our focus is
not on stock markets’ immediate reaction to patent litigation news (such as 1- or 3-day
cumulative abnormal returns around the news) because it is not tradable for general investors. As
our litigation portfolio is formed at the end of each month rather than court filing dates, the
subsequent return it provides mainly reflects long-term stock price movements due to the
development of patent litigation in the future 12 months.
We also consider various risk factor models and find that the litigation portfolio generates
alphas (i.e., risk-adjusted returns) of 56-75 basis points per month after we control for relevant
risk factors (e.g., size, value, momentum, profitability, investment factors), for factors related to
R&D and patents, and for mispricing factors. When we focus on the portfolio consisting of
defendants only, we obtain consistent results. Therefore, the significantly positive returns on the
litigation portfolio cannot be attributed to conventional systematic risks and factors. Such a
litigation-return relation is intriguing and calls for explanations, as the conventional wisdom
suggests that patent litigation is often costly and creates long-term uncertainty.
It is possible that our findings are driven by particular industries. That is, certain fast-
growing, high-tech industries might experience both high stock returns and more patent lawsuits.
To examine this possibility, we implement the following matched-samples analysis: for every
treated firm involved in patent litigation, we find a matched firm that is in the same industry and
has similar firm characteristics, but has not been involved in patent litigation in the prior year;
we then form a control portfolio consisting of those matched firms, so we may examine the
difference in the returns generated by both the litigation portfolio and our control portfolio. The
2
By focusing on court filing dates in establishing our portfolio, we are being particularly cautious; Bessen and
Meurer (2012) note that not all lawsuits are announced, and that there is sometimes a delay between the court filing
date and the announcement date. It is also worth noting that a plaintiff in patent litigation is not necessarily the party
that challenges others’ infringements. In cases of declaratory judgments (DJ), the alleged infringer is the plaintiff,
and the patent owner claiming to own patent rights is the defendant. When claiming for a declaratory judgment, the
plaintiff asks the courts to provide clarity (e.g., ruling that there is no infringement, ruling that the patent owner’s
claim is invalid or unenforceable). Thus, we study both parties—plaintiffs and defendants—due to the unique role
that declaratory judgments play in patent litigation. 9.9% of our cases are declaratory judgments, and our results are
robust to excluding these cases from our analysis.
3
The event-time portfolio approach treats each stock involved in each litigation case as an event, and forms a
portfolio based on all events. Thus, statistical inferences based on event-time portfolios will be subject to issues
including cross-correlation of event returns and overweighing stocks with multiple cases.

returns of the litigation portfolio consistently outperform those of the control portfolio,
suggesting that our baseline finding cannot be attributed to industry-specific causes.
To further examine if the predictive power of patent litigation for future stock returns is
distinct from that of existing return predictors, we implement monthly Fama-MacBeth
regressions for all CRSP/Compustat firms by controlling for various firm characteristics,
including size, book-to-market ratio, lagged stock returns, momentum, R&D expenditure, patents,
operating profit, cash flow, financial constraints, leverage, profit margin, and industry
concentration, as well as industry fixed effects. We find a significantly positive coefficient of
0.2%-0.3% on the indicator variable associated with a firm that experiences at least one patent
lawsuit over the past 12 months. This result, which suggests that the litigation-return relation we
document is different from other documented patterns with respect to return predictability, calls
for a deeper analysis.
We recognize, of course, that patent infringement does not always result in litigation; in
particular (especially regarding how our results relate to defendants’ returns), an infringing
defendant might find it optimal to settle prior to a lawsuit.4 However, a firm’s choice to defend
itself in courts is public information to the market, and thus should not predict stock returns and
alphas unless some investors are unaware of, or underreact to, such information.
We propose four possible explanations for the intriguing pattern that firms involved in
patent litigation experience significantly positive stock returns in the future. First, these firms
may, on average, benefit from being involved in patent litigation, 5 and this benefit may be
consistently undervalued by the stock market due to the complexity of patent lawsuits, investors’
4
In evaluating patent disputes, it is important to be aware of their endogenous nature (Bessen and Meurer, 2006;
2013). For example, Bessen and Meurer (2013) note that “the rate of lawsuit filing depends as much on the
frequency of disputes as the frequency of bargaining breakdown.” Also, Lemley, Richardson, and Oliver (2018) use
survey data to show that about one-third of alleged infringement results in litigation. This indicates that litigation is
not an infrequent result of negotiations between litigants to address potential infringement.
5
While the common wisdom suggests that plaintiffs initiate litigation only when they expect to benefit from it, it is
also possible for patent litigation to benefit defendants. In April 2008, Seagate sued STEC for patent-infringement;
the suit pertained to patents relating to solid-state drives (SSDs). Although one might expect litigation to be value-
destroying in this case, the lawsuit provided an opportunity for STEC to establish the value and strength of its SSD
patents. In particular, its CEO indicated that “STEC will take appropriate action to protect its interests, including
seeking the invalidation of Seagate’s patents” (Cheung, 2008). The lawsuit was dropped in the following year, with
no licensing agreement or financial exchange. Around this time, STEC’s CEO expressed how the events around this
agreement helped establish the validity of its SSD patents: “We have always contended that SSD does not borrow
from existing hard-drive technology but rather offers an all-together new approach to storage. We view the dismissal
as a vindication of our technology” (Mearian, 2009).

limited attention or ambiguity aversion to litigation, and/or systematic underpricing.6 Second,
these firms share a common exposure to an unknown or unspecified systematic risk associated
with patent competition and/or litigation, and thus provide higher expected stock returns as
compensation for bearing higher risk exposure. Third, systematic risk related to financial
constraints (Li, 2011) could exist, such that more financially constrained litigants are then
associated with higher expected returns. Last, firms that are rich in cash or appear promising in
future cash flows are more likely to be sued; thus, our findings simply capture the pattern that
cash-rich litigants provide higher subsequent profits and stock returns.
We first discuss the potential benefits of patent lawsuits for both defendants and plaintiffs
that could be undervalued by the stock market as follows. First, for both parties, an allegation of
infringement signals the value of patents and provides the public with a gauge of the potential
value at stake. For example, more valuable patents tend to experience more litigation and attract
additional citations following litigation (Lanjouw and Schankerman, 2001). Indeed, previous
evidence shows that the number of patent citations received is associated with greater patent
value (Harhoff, Narin, Sherer, and Vopel, 1999; Sampat and Ziedonis, 2005; Kogan et al., 2017);
as a result, the publicity associated with patent litigation delivers more information to investors
(albeit with a potential delayed reaction). It is difficult for investors to effectively value or
ascertain the validity of patents, and the litigation process helps clarify patent value (Marco and
Vishnubhakat, 2013).7 Using patent lawsuits, investors obtain more information about litigated
and other associated patents and assess their value more accurately. For example, Kiebzak,
6
The literature shows that investors consistently undervalue R&D-intensive firms owing to concerns about technical
uncertainty associated with R&D activities, which leads to underpricing and return predictability (see, e.g., Lev and
Sougiannis 1996; Aboody and Lev, 2000; Chan, Lakonishok, and Sougiannis 2001; Lev, Sarath, and Sougiannis
2005). Eberhart, Maxwell, and Siddique (2004) present evidence consistent with investor underreaction to R&D
increases. Cohen, Diether, and Malloy (2013) and Hirshleifer, Hsu, and Li (2013) both argue that investors have
limited processing power for complex innovations in patents and thus undervalue innovative efficient firms.
Moreover, theoretical models show that investors are more skeptical of investment opportunities when they
perceive greater uncertainty (see, Dow and Werlang 1992; Chen and Epstein 2002; Cao, Wang, and Zhang 2005;
and Bossaerts et al. 2010). Moreover, the psychology literature finds that individuals tend to interpret signals more
skeptically and with greater risk when they have less processing fluency with those signals (e.g., Alter and
Oppenheimer 2006; Song and Schwarz 2008, 2009).
7
The litigation process helps clarify (over the course of the legal proceedings) a firm’s patent enforcement ability
and rights. Litigation can thus help initially signal patent value and resolve associated uncertainties, albeit with a
delay. Related to this point, Marco and Vishnubhakat (2013) find that stock market reactions associated with the
resolution of patent uncertainty are comparable to those of initial patent grants: each are approximately 1.0%-1.5%
excess returns. Their findings imply that the uncertainty of patent validity is economically important, and can affect
litigation behavior. Moreover, Graham and Vishnubhakat (2013) note that the effects of legal uncertainty regarding
patent validity are particularly severe in emerging technologies and in areas with rapid growth in patenting activities.

Rafert, and Tucker (2016) note that venture capital investment typically increases with patent
litigation (before eventually declining), consistent with the net positive benefit of patent
litigation in certain situations.
Moreover, patent lawsuits attract media attention and thus highlight barriers to entry by
discouraging future competitors, such as smaller firms with less extensive patent portfolios (Choi,
1998; Shapiro, 2000; Hall and Ziedonis, 2001; Bessen and Meurer, 2013; Cohen, Gurun, and
Kominers, 2018); indeed, prior research (e.g., Cohen, Gurun, and Kominers, 2016a,b, 2018;
Caskurlu, 2017) has highlighted how patent litigation changes firms’ behaviors. The filing of
patent litigation also informs investors of corporate managers’ determination to enforce
intellectual property rights against infringement or to confront groundless charges, which
benefits shareholders (Agarwal, Ganco, and Ziedonis, 2009). For example, in writing about
Eastman Kodak’s efforts to protect and monetize its patent portfolio, Mattioli (2010) notes that
“aggressive litigation has become an increasingly important part of Kodak’s corporate strategy.”
Consequently, there are certain positive aspects to litigation exposure that can potentially
increase firm value, even for defendants.8 Related to the above explanation, even if we ignore the
positive aspects associated with the litigation, patent litigation is typically driven by the true
value of firms’ patents (and thus litigation can be reflective of patent value that is
underappreciated by the market). If a patent is of low value, it is less likely to be litigated or to be
used against a plaintiff. Thus, valuable patents are more likely involved in litigation, and such
litigation likely causes investors to re-evaluate firm value, even with time delay.
To empirically test our explanation of the market’s underreaction to the potential benefits
of patent litigation, we implement further analyses on the subsequent competition, profitability,
and information delay (i.e., the price of a stock is adjusted more slowly). Reflecting increased
barriers to entry associated with patent litigation, we find that litigants experience less industry
competition (measured by Similarity and HHI from Hoberg and Phillips (2016)) following
litigation. Similarly, we find that firms experiencing patent litigation tend to be more profitable
in the long run: firms involved in patent litigation are associated with a 3.0% increase in average
8
To the extent that the litigation will result in a trial (as opposed to a settlement), the market values the ability to
better evaluate management with information revealed over the course of a trial and its judgment. For example,
Haslem (2005) notes that litigation resolution by court decisions dominates out-of-court settlements (from
shareholders’ perspectives), and attributes his results to the valuable information associated with court judgments.

return on equity (ROE) over the subsequent five years. This finding indicates that the benefits
associated with patent lawsuits, on average, exceed the associated costs.
Consistent with our findings being driven by investors’ delayed reactions to the benefits
from litigation initiations, we find a stronger litigation-return relation among the types of firms
with greater information delay. Specifically, we provide double-sorts using both stock return R2
(Hou, Peng, and Xiong, 2013) and Hou and Moskowitz’s (2005) price-delay measure. Across all
models, we find that abnormal returns are significantly larger among firms with greater
information delay (lower stock return R2 or higher price delay). Firms with greater information
delay experience monthly excess returns and alphas that are 65 to 107 basis points higher than
those of firms with less information delay.
Consequently, to the extent that it takes time for investors to fully appreciate patent-
related news, our findings offer new evidence on patent litigation to the asset pricing literature.
In particular, we demonstrate the presence of the market’s delay in reacting to benefits associated
with patent litigation; indeed, litigation is an important event that helps the market understand or
re-evaluate the value of a firm’s patent portfolio.9 We also provide intriguing evidence and new
insights into the effects of patent litigation on shareholder value. Although prior studies highlight
the pernicious effects of patent litigation, we show that the net effect of patent litigation is
positive: by increasing the market value (or simply the awareness) of firms’ intellectual property
and by deterring potential competition, litigation’s net effect is positive, despite the direct and
indirect costs of addressing a lawsuit. Our evidence does not negate the significant direct and
indirect costs associated with patent litigation, as discussed in Footnote 1.
Further tests do not support our second explanation (i.e., firms share a common exposure
to an unknown or unspecified systematic risk associated with patent competition and/or
litigation). Whereas a risk-based explanation suggests a price drop following the news of patent
litigation (as investors discover new risk exposure and start to discount future cash flows to a
greater degree), we find positive or insignificant abnormal stock returns in the [-1, 1] and [-3, 3]
9
Our study is related to the broader literature on mispriced intangibles. Aside from the innovation and R&D
literature, other examples of mispriced intangibles include corporate governance (Gompers, Ishii, and Metrick,
2003), executive perks (Yermack, 2006), social norms (Hong and Kacperczyk, 2009), and employee satisfaction
(Edmans, 2011).

windows around the event dates.10 Moreover, if the risk-based explanation holds, then the return
on the litigation portfolio is driven by heterogeneous exposure to the new risk, and can thus serve
as a mimicking factor for the risk. We implement two-pass regressions to test if the return on our
litigation portfolio is priced in the returns of individual stocks (see Cochrane, 2001). However,
we do not find that the sensitivity of individual stocks’ returns to the litigation portfolio return
(i.e., the beta to the hypothetical litigation risk) is associated with significantly positive slopes in
the cross-section (i.e., the price of risk for the hypothetical litigation risk).
Further tests show that our baseline finding cannot be explained by systematic risk
related to financial constraints or by litigants pursuing cash-rich firms. We do not find a stronger
litigation-return relation in financially constrained firms that are more subject to systematic
risk.11 Nor are our results concentrated in cash-rich firms, suggesting that firms’ cash balances
are unlikely to be driving our results. As a result, our third and fourth explanations do not receive
empirical support.
This paper examines the influence of patent litigation on firms from the perspective of
asset pricing. Many recent studies have focused on the negatives associated with the current
patent system, especially associated litigation costs and effects on innovation (Heller and
Eisenberg, 1998; Jaffe and Lerner, 2004; Lemley and Shapiro, 2007; Ewing, 2011; Cohen,
Gurun, and Kominers, 2018). Indeed, citing a recent letter to Congress by 51 prominent
economics and legal scholars in innovation and intellectual property law, Asay et al. (2015)
assert the harmful effects of patent litigation not only on innovation, but also on R&D and
venture capital investment as well.12 By examining the frequency of litigation, one of the most
controversial aspects of the current patent system, we use this paper to offer new insights into the
10
These announcement returns (based on the date of lawsuit initiations), with our larger and more updated sample,
compares to prior studies based on pre-2000 press data. Those studies show negative announcement effects of
approximately 2-3% of firm value based on firm announcements and news (Bhagat, Brickley, and Coles, 1994;
Lerner, 1995; Bhagat, Bizjak, and Coles, 1998).
11
Mezzanotti (2017) finds that patent litigation’s reduction in a firm’s innovation patterns is driven by exacerbated
financial constraints.
12
In contrast, Farre-Mensa, Hegde, and Ljungqvist (2017) present causal evidence that patent approvals are
associated with start-up success. They note that patents help start-up firms address information asymmetries in four
ways: (1) by providing evidence that a firm can monetize its invention; (2) by increasing a firm’s ability to disclose
details of its invention; (3) by allowing those details to be conveyed with improved certification; and (4) by helping
firms to signal their quality. We recognize that the effects and determinants of patent litigation depend on the unique
circumstances of the litigants. For example, Chien (2009) describes litigation by two large firms as a “sport of kings,”
litigation by an independent inventor against a large firm as “David v. Goliath,” and litigation to exploit a
defendant’s financial distress as “patent predation.”

appropriateness of future reforms. Recognizing that policy makers may wish to consider
reforming the patent approval system in ways that address frequent litigation, we argue that our
study’s findings suggest that lawsuits may indeed have a positive effect with respect to
promoting intellectual property protection; in turn, this positive effect benefits firm value.
We organize our paper as follows. In Section 2, we present our sample construction and
summary statistics. In Section 3, we describe our main results. In Section 4, we examine possible
explanations for our empirical results. We conclude this paper with Section 5.
2. Sample and summary statistics
To construct our data, we collect patent lawsuits related to public firms’ patents by
combining the patent database of public firms (available until 2014) and the Lex Machina
database for patent litigations (available since 2000). We begin by constructing a list of
1,609,059 patents that were granted to public firms from 1983 to 2014 by combining the NBER
patent dataset (originally developed by Hall, Jaffe, and Trajtenberg (2001)), the patent dataset of
Kogan et al. (2017), and the Google Patent database. The updated NBER patent dataset contains
the patent number, application date, grant date, and Compustat firm identifier GVKEY of the
patent assignee (i.e., the firm that owns the patent) of all utility patents granted to public firms
from 1976 to 2006. Kogan et al.’s patent database includes the patent number, application date,
grant date, and Center for Research in Security Prices (CRSP) firm identifier (PERMNO) of the
patent assignee of each utility patent granted to public firms in 1926–2010. Lastly, we use the
Google Patent database to extend the patent data to all patents granted by 2014.13
We start our patent list with the 1983 grant year because patents were valid for 17 years
from the grant date at that time, and the Lex Machina database is available from 2000 (since June
8, 1995, patents are valid for 20 years from their application date). Then, we use this list of
13
To find the GVKEY and/or PERMNO for assignees that own patents granted in 2011–2014, we first collect the
company names and locations of the patent assignees that are public firms and that receive at least one patent in the
period 1976-2010. The company names are from the CRSP and Compustat databases. We then develop a matching
algorithm that matches the name and location of each patent assignee that appears in 2011–2014 to the name and
location in the list of assignees in 1976-2010. As a result, we construct a database of patents granted to U.S. public
firms from 1976 to 2014.

1,609,059 patents in our search in the Lex Machina database, which includes patent litigations’
court filings since 2000. In establishing its database, Lex Machina cleaned and verified daily
updates from the United States federal court system, all United States district courts, the United
States International Trade Commission database (EDIS), and the USPTO. Lex Machina is
regarded as the most comprehensive database of U.S. patent litigation since 2000. Other recent
studies have used data from Lex Machina (Akcigit, Celik, and Greenwood, 2016; Allison,
Lemley, and Schwartz, 2015, 2018; Cohen, Gurun, and Kominers, 2016b, 2018). We derive a list
of 9,343 patent litigations (“Case_IDs”) in which the involved patents were granted to at least
one public firm, which includes those without court decisions or out-of-court settlements.14
When evaluating the effects of patent litigation, it is important to recognize the

differences between practicing entities (PEs) and non-practicing entities (NPEs, or “patent
trolls”).15 Evidence suggests that PEs’ patent litigation has not increased at the same rate as that
of NPEs. A great deal of litigation with PEs involves inadvertent infringement (Bessen and
Meurer, 2013) and, more generally, is driven by the actual infringement itself, as opposed to
being driven by exploiting the profitability of potential lawsuits (Cohen, Gurun and Kominers,
2016b, 2018). We focus on litigation between PEs, and exclude all lawsuits related to patent
trolls. We manually identify litigants that are not manufacturers, universities, government entities,
or non-profit firms, and also identify those whose firms’ activities are classified as intellectual
property consulting according to Google search websites. By merging this list with the sample of
public patent trolls used by Bessen, Ford, and Meurer (2011), we construct a list of NPEs that we
use to filter out NPE-related cases.16 For brevity’s sake, we use the term “patent litigation” to
describe a firm involved in a litigation case that is related to a public firm’s patents, but that is
unrelated to NPEs.
For each patent litigation case unrelated to NPEs, we manually match the plaintiff and
defendant names to the corresponding GVKEY and PERMNO in the CRSP and Compustat
14
Only a small minority of patent lawsuits result in judgments from verdicts. Kesan and Ball (2006) show that,
among patent lawsuits from 2000, 3% of cases result in judgments from jury verdicts or bench trials; the remainder
of cases result in settlements (68%), non-merit dispositions (20%), or summary judgments and dismissals with
prejudice (9%).
15
Nevertheless, Bessen, Neuhausler, Turner, and Williams (2018) find no differences in announcement effects for
PEs and NPEs (after they include their control variables).
16
An alternative approach, to which our results are robust, is to omit cases filed in the Eastern District of Texas (a
venue that is often preferred by patent trolls).

databases. Doing so yields 1,216 unique public firms involved in a total of 4,721 patent litigation
cases in our sample period. We then collect the financial data of these firms from CRSP and their
accounting data from Compustat. We exclude financial firms with SIC codes between 6000 and
6999 and utility firms with SIC codes beginning with 49.
To show how litigation intensity varies over time in our sample, the upper panel of
Figure 1 provides the number of patent litigation cases with publicly-traded plaintiffs in each
year (Plaintiff), the number of cases with publicly-traded defendants in each year (Defendant),
and the number of cases with any publicly-traded litigants in each year (Both).17 We observe
continuous growth in patent litigation for most of our sample period: the number of patent
litigation cases gradually increases to 2007 and then dips in 2008 (perhaps consistent with the
effects of the financial crisis). The number peaks in 2012 with 535 observations in the Both
group, and then gradually declines. The decline in recent years may be attributed partly to the
Leahy-Smith America Invents Act, which reduces patent litigation (e.g., Cohen, Gurun, and
Kominers, 2018). Since a case may involve multiple public firms and their stocks, we also plot
the number of stocks involved in patent litigation (i.e., stock-case observations).18 The lower
panel of Figure 1 provides the annual number of all stock-case observations in each group
(Plaintiff, Defendant, and Both); it shows a mostly similar pattern, and peaks in 2012 (with a
value of 2,027 in the Both group).
Since we also have patent numbers of each litigation case, we find that, in 82.3% of
sample cases, all litigated patents belong to plaintiffs. In addition, in 16.5% of sample cases, all
litigated patents belong to defendants. Lastly, both plaintiffs and defendants own parts of
litigated patents in 1.1% of sample cases. Moreover, as we note in the introduction, our sample
includes declaratory judgments (9.9% of our sample cases), where the alleged infringer is the
plaintiff and asks the court to provide clarity regarding whether infringement is occurring.
17
When both the plaintiff and defendant of a litigation case are public firms, this case is counted in all three groups.
18
A firm involved in multiple cases will be counted as having multiple stock-case observations.
10

3. Empirical Results
3.1. Portfolio analysis for the returns in the subsequent 12 months
We examine monthly stock returns using a calendar-time portfolio approach. At the end
of every month, t, from January of 2000 to November of 2014, we create a portfolio for firms
that were involved in patent litigation within the most recent 12 months (t-11 to t) as the
“litigation portfolio”. These firms are either as plaintiffs or defendants in lawsuit cases involving
patents that are filed in court in month t-11 to t. We hold this portfolio for the next month t+1,
calculate its equal-weighted portfolio return at the end of the month, and then adjust/rebalance
the portfolio in a similar way, based on patent lawsuits filed from t-10 to t+1 at the end of month
t+1.19 We report the portfolio results in two panels in Table 1: Panel A includes all litigation
cases, and Panel B includes the litigation cases with both a public plaintiff and a public
defendant.
We use such a calendar-time portfolio instead of an event-time portfolio, as the latter

treats each stock involved in each litigation case as an event and forms a portfolio based on all
events. Since a stock can often be involved in multiple patent litigations in the same period, an
event-time portfolio will be subject to issues that include a cross-correlation of event returns and
overweighting stocks with multiple cases. More importantly, only the calendar-time portfolio
approach is a practical trading strategy that can deliver trading profits (if any) to investors and
thus has asset pricing implications. On the other hand, as our litigation portfolio is formed at the
end of each month rather than court filing dates (event dates), its return does not reflect stock
markets’ immediate reaction to patent litigation news (such as 1- or 3-day cumulative abnormal
returns). Instead, its return better reflects long-term stock price movements due to the
development of patent litigation in the future 12 months.
In Panel A of Table 1, we present the average monthly excess returns (i.e., monthly
returns in excess of the one-month T-bill rate) and the alphas based on various linear factor
19
Because the number of stocks involved in the portfolio is small (212, on average), we focus on equal-weighted
portfolio returns to ensure that the effects of patent litigation on all stocks are presented, following Loughran and
Ritter (2000), Chan, Lakonishok, and Sougiannis (2001), Eberhart, Maxwell, and Siddique (2004), and Lyandres,
Sun, and Zhang (2007). If a firm is involved in two cases as a plaintiff and in one case as a defendant, then it is
weighed by three in the litigation portfolio. The results based on the value-weighted portfolios are robust, albeit with
weaker statistical significance.
11

models (to control for various systematic risk or other potential explanatory factors) of the
litigation portfolio of all litigation cases.20 In Model 1, we present the average monthly excess
return, which is as high as 102 basis points per month with a t-statistic of 2.07 based on Newey-
West adjustment. Such an estimate is of reasonable statistical significance, especially given that
our sample period is only 179 months long (February 2000 to December 2014).
In order to consider various systematic risk or other potential explanatory factors in

Models 2 to 8, we conduct time-series regressions by regressing the monthly excess returns of
the portfolio on various combinations of return factors, and then report the estimate and
statistical significance of the intercept term (“alpha”) in Panel A. In the Fama-French four-factor
model (Model 2), the alpha is 60 basis points per month with a t-statistic of 3.99. The six-factor
model of Fama and French (2015) that includes the profitability factor RMW and the investment
factor CMA (Model 3) generates an alpha of 57 basis points per month with a t-statistic of 3.47.
These findings suggest that the return of the litigation portfolio cannot be explained by the size
effect, value effect, momentum effect, profitability effect, or the investment effect.
In Models 4 to 6, we add each of the following innovation-related factors to Model 2: an

R&D factor, a patent factor, and an innovative efficiency factor. The R&D factor is the
difference between the monthly returns of the high R&D portfolio and that of the low R&D
portfolio. The high (low) R&D portfolio consists of firms with R&D capital (the R&D
expenditure over the rolling five-year period, with 20% annual depreciation) divided by the
market value of equity in the top 20% (bottom 20%), following Chan, Lakonishok, and
Sougiannis (2001) and Lev, Sarath, and Sougiannis (2005).21 The patent factor is the difference
between the monthly returns of the high patent portfolio and those of the low patent portfolio.
The high (low) patent portfolio consists of firms with the number of patents granted over a
rolling five-year period (with 20% annual depreciation) divided by total assets in the top 20%
(bottom 20%).22 The innovative efficiency factor is the difference between the monthly returns
20
Our one-month T-bill rate and Fama and French factors—MKT, SMB, HML, UMD, RMW, and CMA—are from
the Kenneth French data library. The Hou, Xue, and Zhang q-factors—IA and ROE—are from Lu Zhang. The
Stambaugh and Yuan mispricing factors—MGMT and PERF—are from Yu Yuan's website. We thank Kenneth
French and Yu Yuan for making the data publicly available, and thank Lu Zhang for sharing the data with us.
21
R&D capital in year t is defined as the sum of [1- 0.2τ] times R&D expense in years t-τ (with τ ranging from 0 to
4), following Chan, Lakonishok, and Sougiannis (2001).
22
We scale the number of granted patents by total assets following Hall, Jaffe, and Trajtenberg (2005) and Noel and
Schankerman (2013).
12

of the high efficiency portfolio and those of the low efficiency portfolio. The high (low)
efficiency portfolio consists of firms with the log of the number of patents granted over a rolling
five-year period (with 20% annual depreciation) minus the log of one plus the industry-adjusted
R&D expenditure over a rolling five-year period (with 20% annual depreciation) in the top 20%
(bottom 20%). 23 We find positive coefficients on the R&D factor and the patent factor.
Nevertheless, the alphas from the models that include innovation-related factors range between
56 and 58 basis points per month and remain statistically significant (with t-statistics above 3),
suggesting that the return of the litigation portfolio cannot be explained by R&D- or patent-based
factors.
In Models 7 and 8, we consider two new factor models and find even higher alphas: the
q-theory factor model of Hou, Xue, and Zhang (2015) and the mispricing factor model of
Stambaugh and Yuan (2017). The q-theory factor model includes a market factor, a size factor,
an investment intensity factor, and a profitability factor that are derived from a q-theory model;
the mispricing factor model includes a market factor, a size factor, a management factor, and a
performance factor. The former and the latter generate alphas of 75 and 72 basis points per
month with t-statistics of 3.74 and 3.33, respectively. These results suggest that the return of the
litigation portfolio cannot be attributed to investment-based risk or common mispricing factors.
Our results remain similar in Panel B of Table 1, in which we restrict our sample to
lawsuits where both the plaintiff and defendant are public. The excess returns and alphas of the
litigation portfolio are comparable to (and slightly larger than) the counterparts in Panel A,
which suggests that market reactions seem to be even more positive when the opposing party in
the litigation is another public firm. This panel thus confirms that our results are not driven by
large public firms’ advantages in patent litigation against smaller, private firms. As we observe
consistent results across different case samples in Table 1, we will only report the results based
on all litigation cases for the rest of our analyses for brevity.
We further examine the robustness of Table 1 by using alternative definitions for our
sample of relevant firms. In Panel A of Table 2, we include firms that were involved in any
patent litigation in month t-11 to t but were not involved in any patent litigation in months t-23 to
23
The construction of the innovative efficiency factor is motivated by Cohen, Diether, and Malloy (2013) and
Hirshleifer, Hsu, and Li (2013).
13

t-12 (the prior year). We consider this alternative approach in constructing our sample in order to
mitigate the concern that some firms may be involved in patent litigation for many years and are
always present in our portfolio. That said, we find that our results are robust when we exclude
such firms: in Panel A, the mean excess returns and alphas of the portfolio range between 56 and
108 basis points per month, with t-statistics ranging from 2.08 to 3.57.
In Panel B of Table 2, we restrict treated firms to only defendants and find that our results
are robust when we focus on such firms: the mean excess returns and alphas of the defendant
portfolio are commensurate to (albeit slightly weaker than) their counterparts in Table 1. This
finding further supports our earlier argument that defendants in patent litigation cases may also
benefit from the initiation of patent lawsuits.
As discussed earlier, it may be inappropriate to separate our sample into the plaintiff and
defendant groups because, with Declaratory Judgments, the plaintiffs are alleged infringers and
the defendants are patent owners claiming to own patent rights. In addition, our analyses thus far
suggest that both parties experience significantly positive price increases in most scenarios. Thus,
in subsequent analyses, we include all plaintiffs and defendants in our test sample.
Another possible concern is if the findings from our portfolio analysis in Table 1 are
subject to industry effects, for some industries may be subject to greater patent litigation risk and
also provide greater stock returns at the same time. To address this concern, we construct
portfolios that include only industry-matched firms in Table 3. In this approach, we define
“treated” firms as those that experienced patent litigation within the previous 12 months. For
each treated firm in each month, we match it with another firm (i.e., control firm) with the same
SIC 2-digit industry code and with the closest distance in size, book-to-market ratio, momentum,
profitability, and investment. At the end of every month from December of 2000 to December of
2014, we create an equal-weighted portfolio (“Control”) for these control firms in each month
and then track its equal-weighted return in the next month. Similarly, we create an equal-
weighted portfolio (“Treated”) for these treated firms, so we can find matched control firms in
each month and then track their equal-weighted returns in the next month. We also construct a
difference portfolio by taking a long position in the treated portfolio and taking a short position
in the control portfolio. We then report the mean excess returns and alphas of the treated
14

portfolio, the control portfolio, and the difference portfolio. The difference portfolio generates
monthly returns of 30-45 basis points per month, which are statistically significant at the 5%
level in all models.
Consequently, we use Tables 2 and 3 to confirm the robustness of a positive litigation-

return relation by excluding firms that frequently experience patent litigation, by focusing on
defendants, and by controlling for industry-specific issues.
3.2. Fama-MacBeth cross-sectional regressions for returns
In this section, we continue our analysis by using monthly Fama-MacBeth (1973) cross-
sectional regressions for all public firms (except financial and utility firms) in the
CRSP/Compustat database, which enables us to control more directly for characteristics
potentially associated with returns, so we may examine whether the effect of patent litigation on
stock valuation is distinct from that of other firm or industry characteristics. In these regressions,
our focal variable is an indicator variable, DUMMY_CASE, for whether a firm experiences patent
litigation in the prior 12 months, either as a plaintiff or a defendant. The other control variables
include returns over the previous month (RET), the log of the book-to-market ratio (LOGBM),
the log of the market value of equity (LOGME), the log of one plus the R&D expense over the
past five years using an annual discount rate of 0.2, divided by total assets (LOGXRD), the log of
one plus the number of patents granted in the past five years divided by the book value of total
assets (LOGNPATENT), cumulative returns over the past twelve months with a one-month gap
(MOM11), cumulative returns over the past three years with a one-year gap (MOM36), the
growth rate of the book value of total assets (INV), stock operating profit defined by revenue
minus the costs of goods sold, interest expense, selling, general and administrative expense,
divided by book value of equity (OP), cash flow scaled by total assets (CF), the Kaplan-Zingales
index (KZ), long-term debt plus current liabilities scaled by the book value of equity
(LEVERAGE), gross profit scaled by sales (PM), and the Herfindahl-Hirschman Index (HHI),
based on the sales of shares in industries defined by 2-digit SIC codes.
15

In Table 4, we report the summary statistics (mean, median, and standard deviation) of
the related variables for the following four litigation groups: (1) Plaintiff: those in which the firm
was a plaintiff in at least one patent lawsuit and was not a defendant in any litigation in the prior
year; (2) Defendant: those in which the firm was a defendant in at least one patent lawsuit and
was not a plaintiff in any litigation in the prior year; (3) Mixed: those in which the firm played
both roles (i.e., it was a plaintiff in at least one patent lawsuit and was a defendant in at least one
patent-related litigation in the prior year); and (4) No case: those in which the firm was neither a
plaintiff nor a defendant in any patent lawsuit in the prior year. Distinguishing our results in this
manner enables us to evaluate the differences between firms based on their status as litigants.
The median Plaintiff firm experiences two lawsuits per year, the median Defendant firm
also experiences two lawsuits per year, and firms that experience both types of litigation (Mixed)
experience eight lawsuits per year. Consistent with the intuition that larger firms experience
significantly more litigation, the number of cases per year are skewed; for example, Mixed firms
experience a mean of 13 lawsuits per year. We find that the median book-to-market (BM) ratio is
larger for firms that do not experience any litigation compared to those that do experience
litigation, and R&D capital stock (XRD) is smallest for firms that do not experience litigation.
Firm size (ME) is consistent with larger firms experiencing more litigation: firms without any
litigation are smallest, plaintiffs are slightly smaller than defendants, and firms that are both
plaintiffs and defendants are the largest. Plaintiffs have more patents (NPATENT) than
defendants, consistent with the former group’s desire to enforce their intellectual property rights.
Median returns over the prior three years (MOM11 and MOM36) and operating performance (OP)
are smallest for firms that do not experience litigation, perhaps consistent with these firms being
less likely to be targeted for litigation (or behaving more conservatively to avoid litigation).
Consistent with litigation targeting relatively cash-rich firms, firms that do not experience any
litigation have the lowest level of cash flow (CF) and the highest measure of financial constraints
(KZ) of all the groups. Similarly, litigation intensity increases with profit margins (PM): firms
not experiencing litigation have the lowest profit margins, and those that are both plaintiffs and
defendants have the highest profit margins. Finally, litigation intensity declines with industry
concentration (HHI), since firms that do not experience any litigation have the highest value of
HHI, and those that acted as both plaintiffs and defendants have the lowest value of HHI.
16

In Table 5, we provide the means and t-statistics based on the times series of the
coefficients on all explanatory variables from our Fama-MacBeth cross-sectional regressions.
Our focal variable is DUMMY_CASE, which is an indicator variable equal to one for a firm in
month t if the firm is involved in any patent litigation over the past 12 months (t-11 to t) as either
a plaintiff or defendant, and zero otherwise. In each month t from December 2000 to December
2014, we conduct a cross-sectional regression by regressing the monthly excess returns of all
firms in month t+1 on DUMMY_CASE of all firms in month t, all control variables known in
month t, and industry fixed effects based on 2-digit SIC codes. These cross-sectional regressions
let us estimate the coefficient on DUMMY_CASE in every month. We then test if the average of
monthly coefficients on DUMMY_CASE is statistically significant by using the time-series of
monthly coefficients, and report the average and t-statistics in Table 5. We apply the same
procedure for the coefficients on control variables. The first four specifications (Models (1)
through (4)) do not use industry fixed effects; the final four specifications (Models (5) through
(8)) include industry fixed effects.
We find that the litigation-related variable (DUMMY_CASE) is positive in all

specifications, with a magnitude of 23-33 basis points per month; the t-statistics range between
2.50 and 3.65. The signs and magnitudes of the coefficients of other control variables are largely
consistent with the literature. Consequently, our baseline findings that firms involved in patent
litigation are associated with significantly higher subsequent stock returns remain robust when
we control for relevant firm- and industry-specific variables. Therefore, firm and industry
characteristics cannot (fully) explain our baseline results.
4. Possible Explanations
We now examine four possible explanations for our baseline finding that patent litigation
positively predicts stock returns. First, substantial benefits related to patent lawsuits might exist
that exceed the associated costs, and these benefits might be undervalued by the market due to
information delay. Second, systematic risk related to patent litigation might exist, and firms
involved in patent litigation carry higher exposure to such risk, which provides greater expected
returns. Third, systematic risk related to financial constraints might exist, such that financially
17

constrained litigants may be subject to risk to a greater extent. Finally, only firms that are rich in
cash are sued and provide higher future stock returns.
4.1. Potential benefits from patent litigation
Our first explanation is that the benefits associated with patent litigation outweigh the
associated costs, but these benefits are generally undervalued by investors due to information
delay. The benefits should be particularly intuitive for plaintiffs: they ought to only litigate when
doing so increases value, and the firm is likely to win its lawsuit. In addition, the initiation of
patent lawsuits may illustrate to investors the economic value or unique applications of plaintiffs’
patents. The disclosure of a patent lawsuit also informs the stock market of managerial
determination and aggressiveness in monetizing and protecting its intellectual property (Agarwal,
Ganco, and Ziedonis, 2009), which also positively contributes to firm value.
For defendants, being sued may increase their stock prices for the following reasons. First,
defendants who feel confident that they will win their lawsuits do not choose to settle their issues
out of court. Second, a lawsuit highlights the profits earned (or potentially being earned) from
the defendants’ use of certain intellectual property. In other words, defendants would generally
not be sued if they were not generating (or are not expected to generate) substantial profits from
the alleged patent infringement. Thus, patent litigation provides more information about the
(expected) value of the defendant to the market. Third, more generally, a lawsuit reduces the
information asymmetry associated with the defendant’s profits and/or innovations for investors
(because more information about each firm’s intellectual property is revealed over the course of
the lawsuit), which may also improve stock valuation. Fourth, patent litigation highlights the
substantial barriers to entry associated with a defendant’s operations and products, which may
deter potential competitors.
To test the explanation based on net benefits associated with patent litigation, we first
examine how patent litigation is associated with future competition in Table 6. In particular, we
examine the effects of patent litigation on future five-year and three-year averages of Similarity
and HHI as defined in Hoberg and Phillips (2016), since both are important measures of
18

competition in an industry (these measures are based on textual analysis from firms’ 10-K annual
filings of their business descriptions). We perform annual Fama-MacBeth cross-sectional
regressions by regressing average Similarity and HHI over the subsequent three-year and five-
year periods against DUMMY_CASE (the indicator variable for a firm being a party in patent
litigation within the prior 12 months) and other explanatory variables, similar to our approach in
Table 5, except that we use annual regressions instead of monthly regressions. As we do in Table
5, we control for investment (INV), the log book-to-market (LOGBM), the log market value of
equity (LOGME), the log patent output (LOGNPATENT), and the log R&D investment
(LOGXRD). We also include industry fixed effects.
Consistently, our results point to the effects of increased barriers to entry following patent
litigation. Firms’ products become more differentiated as Similarity in the following five years
(three years) declines by 0.28 (0.29) around this time. Industries also become less competitive as
defined with the sales-based HHI, with average future HHI increasing by 1.5% in the subsequent
five-year and three-year periods. Consequently, using a range of industry-level proxies of
competition, we find that patent litigation leads to increased barriers to entry.
Another way to assess the increased barriers to entry associated with patent litigation is to
examine future profitability. In Table 7, we examine firms’ subsequent three-year and five-year
average ROE, and perform annual Fama-MacBeth cross-sectional regressions against
DUMMY_CASE (the indicator variable for a firm being a party in patent litigation within the
prior 12 months) and other explanatory variables, similar to our approach in Table 6. We
examine the average ROE over the subsequent three-year and five-year periods since the benefits
associated with the patent litigation are likely to be recognized over time, albeit with a delay. As
we do in Table 6, we control for investment (INV), the log book-to-market (LOGBM), the log
market value of equity (LOGME), the log patent output (LOGNPATENT), and the log R&D
investment (LOGXRD). Additionally, to control for persistence in profitability, we include the
prior year’s ROE (ROE). Also, to control for mean reversion in profitability (Fama and French,
2000), we include the prior one-year change in ROE (ΔROE). We also include industry fixed
effects.
19

Consistent with our proposition of litigation benefits, we find that the coefficient on
DUMMY_CASE is significantly positive: firms involved in any patent litigation (DUMMY_CASE
=1) are associated with an increase in the mean five-year ROE of 3.0% and an increase in the
mean three-year ROE of 2.4%. The slopes of the other explanatory variables are also as expected,
and experience little change with respect to the two different windows of future profitability.
These results support our argument that patent litigation may be, on average, beneficial to patent
litigants by both signaling the value of patents and the potential of associated profits to the public
and highlighting barriers to potential new competitors.
Tables 6 and 7 thus collectively help identify the mechanisms of our results by providing
evidence of less competition in litigants’ industries, with the associated improvements in their
profitability. These results are associated with increased barriers to entry.
4.2. Undervaluation due to information delay
After presenting the positive relation between patent litigation and subsequent
profitability and the negative relation between patent litigation and future competition, we argue
that investors do not immediately realize and thus underreact to the positive value associated
with firms’ involvement in patent litigation. Such underreaction leads to our baseline finding that
litigation predicts stock returns. The details of patents and lawsuits are often complicated in ways
that challenge investors, even institutional ones, to readily analyze and comprehend these
details.24 In Table 8, we examine the information delay argument by using a one-way sorted
portfolio.
To do so, we rely on two information delay measures: stock return R2 as in Hou, Peng,
and Xiong (2013) and the delay in stock-price reactions to new information as in Hou and
Moskowitz (2005). In Panel A, we use the stock return R2 to measure information delay.
Following Hou, Peng, and Xiong (2013), stock return R2 is calculated as the R2 from regressing
the stock’s monthly returns on the contemporaneous returns of the CRSP value-weighted index
portfolio and industry portfolio, based on Fama and French 48 industries. We require a minimum
24
See Footnote 5 for a review of prior studies that have provided empirical evidence and explanations for the
market’s undervaluation of innovation-related information.
20

of 24 observations to estimate R2. Hou, Peng, and Xiong (2013) argue that a low R 2 is associated
with price inefficiency, in part by showing that a lower R2 is associated with greater medium-
term momentum, and also associated with stronger long-term price reversal.
In Panel B, we use Hou and Moskowitz’s (2005) price delay measure, which reflects the
delay in stock-price reaction to new information and is mostly driven by frictions in investor
recognition. Following Hou and Moskowitz (2005), we estimate price delay by the following
two steps. In the first step, at the end of June in each calendar year, we calculate the “first-stage
individual stock delay” measure. This measure is defined as one minus the R2 from the
regression of an individual stock’s weekly returns on the market portfolio and four weeks of
lagged returns on the market portfolio over the prior year. In the second step, we derive “second-
stage portfolio delay” measures to mitigate the errors-in-variables problem in individual stock
regressions. Specifically, at the end of June of each calendar year, we sort stocks into deciles
based on their market capitalization. Within each size decile, we then sort stocks into deciles
based on their first-stage individual delay measures. We then compute the equal-weighted
weekly returns of the 100 size-delay portfolios over the following year from July to June, and we
re-estimate the regression in step one by using the entire past sample of weekly returns for each
of the 100 portfolios in the second stage. We then assign the computed delay measures for each
portfolio to each stock within the portfolio, and defined them as stock-level price delay.
In each month from January 2000 to November 2014, we classify firms that had
experienced litigation in the prior 12 months into three groups based on each of the information
delay proxies: the group consisting of firms with information delay proxies below the 30 th
percentile is defined as the “low” group, the group consisting of firms with information delay
proxies above the 70th percentile is defined as the “high” group, and the group consisting of firms
with information delay proxies between the 30th and 70 th percentiles is defined as the “middle”
group.25 We present the mean excess return, the difference in excess return between the high and
low groups (High-Low), and the t-statistic of the difference in Table 8.
25
Specifically, when we use stock return R2 as the proxy for information delay, the high group includes firms with
the lowest 30% R2, the low group includes firms with the highest 30% R2, and the middle group includes the
remaining firms. When we use price delay as the proxy for information delay, the high group includes firms with the
highest 30% price delay, the low group includes firms with the lowest 30% price delay, and the middle group
includes the remaining firms.
21

In both panels, we find that the litigation-return effect is larger among firms with greater
information delay; this difference is statistically significant across models in Panels A and B
based on R2 and price delay, respectively. In Panel A, litigants with low return R 2 are associated
with significantly higher excess returns than those with high return R2, as shown by the
significantly negative differences in the High-Low row. In particular, the differences range from
81 to 107 basis points per month (depending on the model used); all differences are statistically
significant at the 5% level. In Panel B, based on the price delay measure of Hou and Moskowitz
(2005), we again find that litigants with high information delay are associated with significantly
higher excess returns. The differences in excess returns between the high and low groups range
from 63 to 84 basis points per month, and are statistically significant in all but two models.
Table 8 thus provides support for our fourth explanation of our results based on
underraction: the benefits of firms experiencing patent litigation are not immediately observed
and/or understood by investors, which results in positive return drifts in both daily and monthly
frequencies.
4.3. Systematic risk related to patent litigation
In this section, we provide additional analyses to examine if the return predictability

associated with patent litigation can be explained by systematic risk. Firms involved in patent
litigation are subject to discounts in their stock prices due to greater systematic risk exposure,
and are thus expected to provide higher expected stock returns to investors as risk premia.
If our finding is driven by a systematic risk associated with patent litigation, we would
expect stock markets react negatively to patent litigation news because investors should discount
the price when they realize the potential risk. To test this argument, we examine the stock
market’s reaction to the disclosure of patent litigation in our sample, based on Lex Machina from
2000 through 2014. In Table 9, we provide the cumulative abnormal returns (CAR) of a stock in
an event window [-n, m] starting from n days before the disclosure day (day 0) to m days after
the disclosure day. We calculate CAR in two short windows: [-1, 1] and [-3, 3]. We consider
three ways to calculate CAR. Specifically, CAR1 is defined as the cumulative daily returns in
22

excess of the CRSP value-weighted market index in the period; CAR2 is defined using the
CAPM model with market beta estimated during the window of trading days -171 through -22
with a minimum of 100 non-missing observations (as in Bhagat, Brickley, and Coles, 1994);
CAR3 replaces the CAPM model in CAR2 with the Fama-French four-factor model including the
market factor, SMB factor, HML factor, and MOM factor to account for market beta, the beta to
the size premium, the beta to the value premium, and the beta to momentum premium.
We present average CAR in the short windows [-1, 1] and [-3, 3] in two samples: Panel A
includes all litigation cases, and Panel B includes the litigation cases with both a public plaintiff
and a public defendant. We do not find any evidence for significant price drops in either of these
windows. These results thus do not support the explanation of newly discovered risk exposure.
To further examine the risk explanation, we employ a two-pass procedure to test if the
return on the litigation portfolio serves as a risk factor. If the litigation portfolio we construct in
Section 3.1 creates significantly positive monthly excess returns and alphas (as reported in Table
1), that portfolio may be considered as a mimicking portfolio that reflects the risk compensation
for bearing one unit of risk exposure to a systematic risk associated with patent litigation (see
Fama and French (1993)).
We refer to the monthly returns on the portfolios formed by firms that are involved in
patent litigation (litigation portfolio) as the “litigation factor.” Then, we test if this factor exists
in a linear stochastic discount factor model by implementing a two-pass procedure (see Cochrane
(2001)). First, we conduct a rolling window estimation to estimate the beta associated with the
litigation risk, βi,Litigation, for stock i using its stock returns in the most recent 60 or 12 months. For
example, for stock i in month t, we estimate its βi,Litigation,t by regressing its monthly excess
returns on the litigation factor and other factors (MKT, SMB, and HML) from month t-59 (or t-
11) to month t. Then, we conduct a cross-sectional regression for each month; for each month in
our sample period, we regress the monthly excess returns of all stocks on the litigation betas of
all stocks (and other betas, such as market betas) to calculate the coefficient on the litigation
betas for the month. The coefficient on the litigation beta (βLitigation) serves as an estimate of
litigation risk premium (known as “lambda”) in the month. Finally, we test the significance of
the litigation risk premium by the time series mean and standard deviation of the coefficients on
23

litigation betas across all months and report our results in Table 10: a significantly positive
coefficient associated with βLitigation indicates that the litigation factor is positively priced in
testing assets. On the other hand, an insignificant coefficient associated with βLitigation indicates a
lack of evidence that the litigation-return relation is driven by risk.
The results across all panels in Table 10 indicate that the coefficient on βLitigation is
consistently insignificant across various models and specifications.26 In Panel A, we present our
results using 60 months to estimate beta, and we use Panel B to present our results using 12
months to estimate beta. As we cannot find any significant coefficient on βLitigation that reflects
litigation risk premium in the various models in Table 10, we note that the litigation factor is not
priced in the stock market, which casts doubt on the likelihood that our results are driven by any
systematic risk associated with patent litigation.
4.4. Systematic risk related to financial constraints
Another potential risk-based explanation for our results is that costly patent litigation
affects financially constrained firms in particular, as R&D-intensive firms incur greater
systematic risk when they are under financial constraints (Li, 2011). Costly patent litigation
makes these R&D-intensive firms subject to such risk (Lanjouw and Schankerman, 2004), and
this explanation would predict excess returns to be concentrated in those financially constrained
firms. In Panel A of Table 11, we examine this possibility by creating portfolios sorted by
financial constraints, based on the Kaplan-Zingales index (1997). In particular, we classify all
firms experiencing patent litigation by their financial constraints into three groups: the low group
includes firms with financial constraints below the 30 th percentile, the high group includes firms
with financial constraints above the 70 th percentile, and the middle group includes firms with
financial constraints between the 30th percentile and the 70th percentile. We then calculate the
equal-weighted excess returns for each group in each month, and report the mean excess returns
and alphas (similar to Table 8). At the bottom of each panel, we report the mean excess returns
and alphas (and the corresponding t-statistics) of a high-minus-low (High-Low) portfolio that
26
These results use all individual stocks as test assets; however, our results are also robust when we use industries or
portfolios as test assets.
24

takes a long position in the high group and a short position in the low group. If the litigation-
return relation is caused by financial constraints, we would expect a stronger predictive ability in
the high group (i.e., the high group will outperform the low group in excess returns and alphas).
We find that the mean excess returns and alphas of the High-Low portfolio range
between 2 and 27 basis points per month, although these values are not statistically significant.
This finding indicates that the effect of patent litigation on stock returns does not concentrate on
financially constrained firms. Thus, it is difficult for us to attribute the litigation-return relation to
the systematic risk associated with financial constraints. In Panel B, we show that this pattern
holds when we only consider defendants (since this issue is particularly acute among financially
constrained defendants). Our results remain similar to those provided in Panel A.
Panels A and B of Table 11 thus suggest that the higher stock returns associated with
firms involved in patent litigation cannot simply be attributed to systematic risk associated with
financial constraints.
4.5. Cash holdings
In Panel C of Table 11, we consider an important driver of litigation—cash—that may

explain our baseline finding. Firms with larger cash balances are known to attract patent
litigation since they are able and/or are more willing to settle lawsuits. It is possible that our
excess returns are driven by cash-rich firms that both attract litigation and outperform in stock
returns in subsequent periods.
To evaluate this explanation, we implement one-way sorts based on our proxies for cash
holdings, which is defined as cash and marketable securities scaled by lagged total assets. In
each month, we divide firms that had experienced litigation in the prior 12 months into three
groups, based on their cash holdings. As in Panel A, the three groups are defined by the 30th and
70 th percentiles of cash holding: the low group includes firms below the 30th percentile, the high
group includes firms above the 70 th percentile, and the middle group includes firms between the
30 th percentile and the 70th percentile, similar to Panels A and B. We present the mean excess
25

return, the difference in excess return between the low and high groups, and the t-statistic of the
difference in Panel C of Table 11.
We do not find that the positive returns are significantly larger among cash-rich firms,
which indicates that the excess returns are not driven by cash-rich firms being more likely to
attract patent litigation. In Panel D, we provide the results among defendants only, as the impact
of cash on litigation could be more severe among defendants. Our results remain broadly
comparable to those that we provide in Panel C, albeit with statistical significance in Models 3
and 7.
5. Conclusion
Patent litigation has important and wide-ranging effects on firms, and firms are
experiencing patent litigation with increased frequency. In this paper, we examine the effects of
patent litigation on firms’ stock returns, focusing on the role of practicing entities. Our empirical
results suggest that both plaintiffs and defendants experience positive stock returns following the
initiation of patent litigation.
Although there are significant direct and indirect costs associated with this type of
litigation, there are also well-documented benefits, including increases in patent citations and
patent value following litigation, signaling managers’ determination and confidence to the
market, increased barriers to entry for more litigation-intensive industries, reduced information
asymmetries for investors, and increased prominence of firms’ intellectual property. Further
analyses indicate that firms involved in patent litigation experience less future competition and
higher future profits, consistent with the potential benefits associated with patent lawsuits. In
addition, stock returns are stronger among firms with greater information delay, which confirms
an underreaction explanation for the positive litigation-return relation. Consequently, our study
suggests that investors are subject to delay in recognizing the benefits associated with patent
litigation, which results in return predictability.
26

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32

Figure 1: Distribution of plaintiffs and defendants by year
The upper panel of this figure provides the number of patent litigation cases with public firms being plaintiffs in
each year (Plaintiff), the number of patent litigation cases with public firms being defendants in each year
(Defendant), and the number of public firms being plaintiffs or defendant (Both). The lower panel of this figure
provides the number of stocks involved in patent litigation (stock-case observations) in each group in each year. It is
noted that a case may involve multiple public firms and their stocks, the number of stock-case observations is
smaller than the number of litigation cases.
600
500
400
300
200
100
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Plantiff Defendant Both
2500
2000
1500
1000
500
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Plantiff Defendant Both
33

Table 1: The returns of a litigation portfolio consisting of firms involved in patent litigation
In each month from January 2000 to November 2014, we form a portfolio including all firms involved in any patent
litigation case in the past 12 months. We then hold this portfolio and track the equal-weighted return on this
portfolio for the next month. In this table, we report monthly excess returns (Model 1), alphas, factor loadings, and
their t-statistics (provided in parentheses). In particular, we consider the following seven additional models: the
Fama-French-Carhart four-factor model with MKT, SMB, HML and momentum factor UMD (Model 2); the Fama-
French four factor plus profitability factor RMW and investment factor CMA (Model 3) as in Fama and French
(2015); the Fama-French four factor plus a R&D factor, based on R&D expense divided by ME (Model 4) as in
Chan, Lakonishok, and Sougiannis (2001) and Lev, Sarath, and Sougiannis (2005); the Fama-French four factor plus
a patent factor based on the number of patents divided by total assets (Model 5) as in Hall, Jaffe, and Trajtenberg
(2005) and Noel and Schankerman (2013); the Fama-French four factor model plus an efficient factor based on the
efficient minus inefficient portfolio (Model 6) as in Hirshleifer, Hsu, and Li (2013); the Hou, Xue and Zhang (2015)
q-factor model (Model 7); and the Stambaugh and Yuan (2017) mispricing factor model (Model 8). The definitions
of these factors can be found in Section 3.2. Panel A uses all sample observations, and Panel B restricts the sample
to lawsuits where the plaintiff and defendant are both public. The sample period for portfolio returns is from
February 2000 to December 2014. Newey-West adjusted t-statistics are provided in parentheses.
Panel A: Full sample

Model (1) (2) (3) (4) (5) (6) (7) (8)
Excess return/alpha 1.02% 0.60% 0.57% 0.56% 0.58% 0.58% 0.75% 0.72%
(2.07) (3.99) (3.47) (4.00) (3.95) (3.83) (3.74) (3.33)
MKT 1.15 1.16 1.11 1.13 1.16 1.13 1.15
(26.13) (23.55) (27.37) (24.21) (26.24) (20.31) (17.57)
SMB 0.29 0.29 0.15 0.24 0.28 0.04 0.21
(4.02) (4.10) (2.10) (3.38) (3.60) (0.45) (2.46)
HML -0.10 -0.13 -0.08 0.02 -0.09
(-1.66) (-1.83) (-1.55) (0.21) (-1.51)
UMD -0.26 -0.26 -0.21 -0.25 -0.25
(-5.26) (-5.31) (-4.36) (-5.30) (-4.94)
RMW 0.02
(0.19)
CMA 0.06
(0.56)
R&D 0.20
(4.68)
Patent 0.10
(1.83)
Efficiency -0.03
(-0.42)
IA -0.01
(-0.04)
ROE -0.45
(-4.29)
MGMT -0.18
(-2.16)
PERF -0.17
(-2.52)
Observations (# of months) 212 212 212 212 212 212 212 212
2
Adjusted R 91.52% 91.44% 92.95% 91.81% 91.48% 89.49% 88.50%
34

Panel B: Lawsuits with both public plaintiffs and defendants
Model (1) (2) (3) (4) (5) (6) (7) (8)
(2.08) (3.97) (4.17) (3.92) (3.97) (3.82) (3.89) (3.38)
MKT 1.15 1.12 1.09 1.11 1.15 1.11 1.12
(21.67) (19.82) (21.23) (20.46) (21.80) (19.10) (14.86)
SMB 0.28 0.22 0.10 0.19 0.25 0.04 0.16
(4.09) (2.58) (1.39) (2.62) (3.52) (0.63) (2.31)
HML -0.26 -0.21 -0.23 -0.07 -0.24
(-3.68) (-2.80) (-3.82) (-0.66) (-3.56)
UMD -0.26 -0.25 -0.19 -0.24 -0.25
(-3.99) (-3.91) (-3.14) (-4.17) (-3.76)
RMW -0.14
(-1.41)
CMA 0.01
(0.06)
R&D 0.24
(4.05)
Patent 0.17
(2.75)
Efficiency -0.03
(-0.47)
IA -0.22
(-1.74)
ROE -0.46
(-3.63)
MGMT -0.32
(-3.75)
PERF -0.16
(-2.40)
Observations (# of months) 118 118 118 118 118 118 118 118
Adjusted R 2 87.99% 88.00% 90.04% 88.86% 87.98% 85.75% 84.88%
35

Table 2: The returns of a litigation portfolio consisting of firms involved in patent litigation – robustness tests
In this table, we provide the mean excess returns and t-statistics (Newey-West t-statistics are provided in parentheses), with alternative definitions of portfolio
firms. In each month from January 2000 to November 2014, we form a portfolio including all firms involved in any patent litigation case in the past 12 months.
In Panel A, the portfolio includes only firms that are a party to litigation in the past 12 months, but not in the year before the 12-month period. In Panel B, the
portfolio includes only firms that are defendants in the portfolio formation month. We then hold this portfolio and track the equal-weighted return on this
portfolio for the next month. We provide the unadjusted excess returns in Model 1 and consider the following seven additional models: the Fama-French four-
factor model with MKT, SMB, HML and momentum factor UMD (Model 2); the Fama-French four factor plus profitability factor RMW and investment factor
CMA (Model 3) as in Fama and French (2015); the Fama-French four factor plus a R&D factor based on R&D expense divided by ME (Model 4) as in Chan,
Lakonishok, and Sougiannis (2001) and Lev, Sarath, and Sougiannis (2005); the Fama-French four factor plus a patent factor based on the number of patents
divided by total assets (Model 5) as in Hall, Jaffe, and Trajtenberg (2005) and Noel and Schankerman (2013); the Fama-French four factor model plus an
efficient factor based on the efficient minus inefficient portfolio (Model 6) as in Hirshleifer, Hsu, and Li (2013); the Hou, Xue and Zhang (2015) q-factor model
(Model 7); and the Stambaugh and Yuan (2017) mispricing factor model (Model 8). The sample period for portfolio returns is from February 2000 to December
2014.
Panel A: Portfolio firms experiencing no patent-litigation in the year before the past 12 months
No factor Fama-French Fama-French Fama-French Fama-French Fama-French q-theory Mispricing
4-factor 4-factor + 4-factor + 4-factor + 4-factor + 4-factor 4-factor
RMW + CMA R&D Patent Efficiency
t-stat (2.08) (3.55) (3.05) (3.42) (3.43) (3.42) (3.57) (3.31)
Panel B: Portfolio firms defined only as defendants

No factor Fama-French Fama-French Fama-French Fama-French Fama-French q-theory Mispricing
t-stat (1.71) (2.71) (2.88) (2.67) (2.69) (2.66) (3.13) (2.73)
36

Table 3: The returns of a litigation portfolio consisting of matched firms involved in patent litigation
In this table, we provide the mean excess returns and t-statistics (Newey-West t-statistics are provided in parentheses), with alternative definitions of portfolio
firms. Treated firms are those that experienced litigation in the past 12 months, and control firms are matched in the same year by 2-digit SIC codes that have the
closest distance in size, book-to-market ratio, momentum, profitability, and investment. In each month from January 2000 to November 2014, we form the
Treated portfolio including all treated firms (for which we can find matched control firms) involved in any patent litigation case in the past 12 months. We also
form the Control portfolio including all control firms. We then hold these two portfolios and track the equal-weighted returns on these portfolios for the next
month. We provide the unadjusted excess returns in Model 1 and consider the following seven additional models: the Fama-French four-factor model with MKT,
SMB, HML and momentum factor UMD (Model 2); the Fama-French four factor plus profitability factor RMW and investment factor CMA (Model 3) as in
Fama and French (2015); the Fama-French four factor plus a R&D factor based on R&D expense divided by ME (Model 4) as in Chan, Lakonishok, and
Sougiannis (2001) and Lev, Sarath, and Sougiannis (2005); the Fama-French four factor plus a patent factor based on the number of patents divided by total
assets (Model 5) as in Hall, Jaffe, and Trajtenberg (2005) and Noel and Schankerman (2013); the Fama-French four factor model plus an efficient factor based on
the efficient minus inefficient portfolio (Model 6) as in Hirshleifer, Hsu, and Li (2013); the Hou, Xue and Zhang (2015) q-factor model (Model 7); and the
Stambaugh and Yuan (2017) mispricing factor model (Model 8). The definitions of these factors can be found in Section 3.2. The sample period for portfolio
returns is from February 2000 to December 2014.
Excess return/alpha No factor Fama-French Fama-French Fama-French Fama-French Fama-French q-theory Mispricing
Control portfolio 0.73% 0.25% 0.17% 0.21% 0.23% 0.24% 0.28% 0.27%
Treated portfolio 1.03% 0.60% 0.51% 0.56% 0.58% 0.59% 0.71% 0.72%
Treated - Control 0.30% 0.35% 0.34% 0.35% 0.35% 0.34% 0.42% 0.45%
t-stat (2.01) (2.41) (2.29) (2.35) (2.46) (2.34) (2.60) (2.70)
37

Table 4: Summary statistics
This table reports the sample distribution of the firm-year observations that we use in our Table 5 (Fama-MacBeth)
specifications for our sample from 2000-2014. It provides sample statistics (mean, median, and standard deviation)
of firms, organized by litigant type: the Plaintiff group includes firms that are a plaintiff but not a defendant over the
prior year, the Defendant group includes firms that are a defendant but not a plaintiff over the prior year, the Mixed
group includes the firms that are both a plaintiff and defendant in the past year, and the No case group includes the
firms that are not involved in any case in the past year. The related variables we consider include: the number of
lawsuits where the firm is either a plaintiff or defendant over the past 12 months, as either a plaintiff or defendant
(NCASE), monthly stock returns (RET), the book-to-market ratio (BM), the market value of equity (ME), the
cumulative R&D expense over the past 5 years using a discount rate of 0.2, divided by total assets (XRD), the
number of patents granted in the past 5 years divided by the book value of total assets (NPATENT), cumulative
returns over the past twelve months with a one-month gap (MOM11), cumulative returns over the past three years
with a one-year gap (MOM36), the growth rate of the book value of total assets (INV), operating profit defined by
revenue minus costs of goods sold, interest expense, and selling, general and administrative expense, divided by the
book value of equity (OP), cash flow scaled by total assets (CF), the Kaplan-Zingales index (KZ), long-term debt
plus current liabilities scaled by the book value of equity (LEVERAGE), gross profit scaled by sales (PM), and the
Herfindahl-Hirschman Index (HHI), based on sales shares in 2-digit SIC codes. Mean values (aside from NCASE
and RET) are winsorized at the 1% and 99% levels.
Plaintiff Defendant Mixed No case

NCASE Mean 4.516 3.773 12.957 0.000
Median 2.000 2.000 8.000 0.000
Std. Dev 8.794 6.204 15.507 0.000
RET Mean 0.014 0.012 0.010 0.012
Median 0.009 0.009 0.009 0.003
Std. Dev 0.138 0.140 0.122 0.190
BM Mean 1.149 2.067 1.904 1.969
Median 0.371 0.424 0.383 0.584
Std. Dev 4.704 8.577 6.139 7.482
ME Mean 8,398 11,065 17,077 2,218
Median 2,094 2,613 6,716 296
Std. Dev 14,630 17,744 20,545 6,564
XRD Mean 0.227 0.175 0.207 0.148
Median 0.162 0.119 0.166 0.004
Std. Dev 0.245 0.222 0.190 0.299
NPATENT Mean 0.067 0.042 0.056 0.029
Median 0.025 0.008 0.025 0.000
Std. Dev 0.158 0.096 0.099 0.135
MOM11 Mean 0.178 0.157 0.143 0.171
Median 0.086 0.082 0.081 0.046
Std. Dev 0.772 0.576 0.554 0.894
MOM36 Mean 0.403 0.365 0.273 0.346
Median 0.138 0.137 0.096 0.055
Std. Dev 1.336 1.180 1.004 1.568
INV Mean 0.154 0.142 0.142 0.127
38

Median 0.067 0.069 0.069 0.052
Std. Dev 0.404 0.346 0.341 0.407
OP Mean 0.284 0.325 0.334 0.216
Median 0.270 0.290 0.306 0.228
Std. Dev 0.396 0.382 0.292 0.478
CF Mean 0.297 0.264 0.260 0.236
Median 0.206 0.188 0.194 0.123
Std. Dev 0.314 0.273 0.243 0.312
KZ Mean 0.866 0.927 0.737 0.900
Median 0.755 0.786 0.714 0.854
Std. Dev 1.657 1.538 1.375 1.777
LEVERAGE Mean 0.607 0.704 0.589 0.738
Median 0.277 0.297 0.366 0.296
Std. Dev 1.292 1.412 0.989 1.442
PM Mean 0.418 0.392 0.524 0.124
Median 0.518 0.452 0.523 0.357
Std. Dev 1.230 1.168 0.238 1.932
HHI Mean 0.236 0.214 0.198 0.259
Median 0.148 0.150 0.133 0.177
Std. Dev 0.219 0.180 0.161 0.225
N 12,271 15,975 5,612 574,634
39

Table 5: Fama-MacBeth cross-sectional regressions
This table provides the means and t-statistics based on the times series of coefficients on all explanatory variables
from Fama-MacBeth cross-sectional regressions. DUMMY_CASE is an indicator variable equal to one for a firm in
month t if the firm is involved in any patent litigation over the past 12 months (t-11 to t) as either a plaintiff or
defendant, and zero otherwise. In each month t from December 2000 to December 2014, we conduct a cross-
sectional regression by regressing the monthly excess returns of all firms in month t+1 on DUMMY_CASE of all
firms in month t, control variables known in month t, and industry fixed effects based on 2-digit SIC codes. Such
cross-sectional regressions lead to an estimate of the coefficient on DUMMY_CASE in every month. We then test if
the average of monthly coefficients on DUMMY_CASE is statistically significant by using the time-series of
monthly coefficients, and we report the average and t-statistics in this table (Newey-West adjusted t-statistics are
provided in parentheses). We apply the same procedure for the coefficients on control variables. Control variables
include stock returns over the previous month (RET), the log of the book-to-market ratio (LOGBM), the log of the
market value of equity (LOGME), cumulative returns over the past twelve months with a one-month gap (MOM11),
cumulative returns over the past three years with a one-year gap (MOM36), the log of one plus the number of patents
granted in the past 5 years divided by the book value of total assets (LOGNPATENT), the log of one plus the R&D
expense over the past 5 years using a discount rate of 0.2, divided by total assets (LOGXRD), the growth rate of the
book value of total assets (INV), operating profit defined by revenue minus costs of goods sold, interest expense, and
selling, general and administrative expense, divided by the book value of equity (OP), cash flow scaled by total
assets (CF), the Kaplan-Zingales index (KZ), long-term debt plus current liabilities scaled by the book value of
equity (LEVERAGE), gross profit scaled by sales (PM), and the Herfindahl-Hirschman Index (HHI). Continuous
independent variables are winsorized at the 1% and 99% levels. The time-series average of the number of
observations (N) and the adjusted R2 are also reported in the bottom. Newey-West adjusted t-statistics are provided
in parentheses.
40

(1) (2) (3) (4) (5) (6) (7) (8)
DUMMY_CASE 0.0033 0.0032 0.0028 0.0028 0.0025 0.0028 0.0023 0.0023
(3.06) (3.65) (3.19) (3.03) (2.80) (3.43) (2.80) (2.50)
RET -0.029 -0.031 -0.032 -0.034 -0.037 -0.038 -0.039 -0.040
(-4.29) (-4.64) (-4.73) (-4.56) (-5.53) (-5.75) (-5.79) (-5.51)
LOGBM 0.001 0.001 0.001 0.003 0.001 0.001 0.001 0.003
(0.88) (1.63) (1.57) (2.64) (1.73) (2.19) (2.19) (3.12)
LOGME -0.001 -0.001 -0.001 -0.001 -0.001 -0.001 -0.001 -0.001
(-1.29) (-1.32) (-1.82) (-1.53) (-1.10) (-1.17) (-1.69) (-1.53)
MOM11 -0.002 -0.003 -0.003 -0.004 -0.004 -0.004 -0.004 -0.005
(-0.39) (-0.41) (-0.44) (-0.64) (-0.67) (-0.69) (-0.73) (-0.92)
MOM36 -0.003 -0.003 -0.003 -0.002 -0.003 -0.003 -0.003 -0.002
(-1.85) (-1.83) (-1.77) (-1.44) (-2.09) (-2.17) (-2.11) (-1.69)
LOGNPATENT 0.004 0.002 0.003 0.007 0.006 0.006
(0.45) (0.23) (0.25) (0.92) (0.75) (0.64)
LOGXRD 0.003 0.009 0.013 0.001 0.006 0.011
(0.52) (1.58) (2.42) (0.17) (1.25) (2.15)
INV -0.005 -0.005 -0.006 -0.005
(-4.91) (-3.61) (-5.77) (-4.35)
OP 0.006 0.008 0.007 0.008
(4.91) (5.18) (5.54) (5.69)
CF 0.000 0.000
(0.21) (0.01)
KZ 0.000 0.000
(0.25) (0.46)
LEVERAGE -0.001 -0.001
(-1.43) (-1.59)
PM 0.000 0.000
(0.11) (1.31)
HHI -0.002 -0.002
(-1.12) (-1.42)
Industry fixed-
effects No No No No Yes Yes Yes Yes
N 3,399 3,399 3,350 2,857 3,399 3,399 3,350 2,857
Adjusted R2 3.41% 3.99% 4.23% 4.66% 6.16% 6.52% 6.72% 6.79%
41

Table 6: Competition following patent litigation
This table reports the average slopes of Fama-MacBeth cross-sectional regressions for the future three-year and five-
year averages of Similarity and HHI (both as in Hoberg and Phillips, 2016) in models (1) and (2), respectively. All
variables are regressed against the following additional explanatory variables from 2000-2014: a dummy variable
equal to 1 if the firm experiences patent-litigation over the past 12 months as either a plaintiff or defendant
(DUMMY_CASE), the growth rate of the book value of total assets (INV), the log of the book-to-market ratio
(LOGBM), the log of the market value of equity (LOGME), the log of one plus the number of patents granted in the
past 5 years divided by book value of total assets (LOGNPATENT), the log of one plus the R&D expense over the
past 5 years using a discount rate of 0.2, divided by total assets (LOGXRD), and the return on assets (ROA), defined
as operating income before depreciation scaled by the book value of assets. SIC 2-digit fixed effects are included.
The time-series average of the number of observations (N) and the adjusted R2 are reported. All variables (except for
DUMMY_CASE) are winsorized at the 1% and 99% levels. Newey-West adjusted t-statistics are provided in
parentheses.
(1) (2) (3) (4)

Average 5-year Average 3-year Average 5-year Average 3-year
Similarity Similarity HHI HHI
DUMMY_CASE -0.279 -0.289 0.015 0.015
(-2.62) (-3.05) (5.62) (6.67)
INV 1.584 1.541 -0.032 -0.032
(6.53) (6.71) (-12.10) (-10.42)
LOGBM 0.064 0.075 -0.024 -0.025
(1.08) (1.34) (-8.83) (-9.01)
LOGME 0.261 0.265 -0.033 -0.033
(18.88) (18.48) (-32.88) (-32.74)
LOGNPATENT -2.509 -2.304 0.034 0.025
(-1.91) (-1.82) (2.20) (2.12)
LOGXRD 12.267 11.996 -0.318 -0.320
(11.16) (11.76) (-17.94) (-17.13)
ROA -1.033 -1.003 0.002 0.001
(-8.03) (-7.71) (0.40) (0.17)
Industry fixed effects Yes Yes Yes Yes

N 2,760 2,756 2,760 2,756
Adjusted R2 51.56% 50.99% 22.23% 21.12%
42

Table 7: Profitability following patent litigation
In this table, we report the average slopes of Fama-MacBeth cross-sectional regressions of average ROE (defined in
each year as operating income before depreciation scaled by the lagged book value of equity) in the subsequent five-
year (model (1)) and three-year (model (2)) periods from 2000-2014 against the following explanatory variables: a
dummy variable equal to 1 if the firm experiences patent-litigation over the past 12 months as either a plaintiff or
defendant (DUMMY_CASE), the growth rate of the book value of total assets (INV), the log of the book-to-market
ratio (LOGBM), the log of the market value of equity (LOGME), the log of one plus the number of patents granted in
the past 5 years divided by the book value of total assets (LOGNPATENT), the log of one plus the R&D expense
over the past 5 years using a discount rate of 0.2, divided by total assets (LOGXRD), the prior year’s ROE (ROE),
and the one-year change in ROE (ΔROE). SIC 2-digit industry fixed effects are included, and the time-series average
of the number of observations (N) and the adjusted R2 are also reported in the bottom. All variables (except for
DUMMY_CASE) are winsorized at the 1% and 99% levels. Newey-West adjusted t-statistics are provided in
parentheses.
(1) (2)
Average 5-year Average 3-year
ROE ROE
DUMMY_CASE 0.030 0.024
(19.07) (8.03)
INV -0.078 -0.068
(-8.59) (-8.09)
LOGBM -0.012 -0.013
(-1.50) (-1.87)
LOGME 0.018 0.016
(14.96) (17.87)
LOGNPATENT -0.010 -0.007
(-0.22) (-0.15)
LOGXRD -0.470 -0.447
(-21.33) (-20.75)
ROE 0.692 0.699
(19.41) (22.72)
ΔROE -0.086 -0.079
(-5.16) (-3.81)
Industry fixed-effects Yes Yes

N 2,984 2,983
Adjusted R2 55.46% 59.22%
43

Table 8: Portfolio analysis conditional on information delay
In this table, we provide the mean excess returns and t-statistics of various portfolios conditional on information delay. We consider two information delay
proxies: stock return R-squared in Panel A, and the price delay measure from Hou and Moskowitz (2005) in Panel B. In each month from January 2000 to
November 2014, we form three portfolios by assigning all firms involved in any patent litigation case in the past 12 months into three groups: the Low group
includes firms with information delay below the 30th percentile, the Middle group includes firms with information delay between the 30 th and 70 th percentiles, and
the High group includes firms with information delay above the 70 th percentile. We then hold these portfolios and track the equal-weighted return on these
portfolios for the next month. We also form the High-Low portfolio by taking a long position in the High portfolio and a short position in the Low portfolio. We
provide the unadjusted excess returns in Model 1 and consider the following seven additional models: the Fama-French four-factor model with MKT, SMB,
HML and momentum factor UMD (Model 2); the Fama-French four factor plus profitability factor RMW and investment factor CMA (Model 3) as in Fama and
French (2015); the Fama-French four factor plus a R&D factor based on R&D expense divided by ME (Model 4) as in Chan, Lakonishok, and Sougiannis (2001)
and Lev, Sarath, and Sougiannis (2005); the Fama-French four factor plus a patent factor based on the number of patents divided by total assets (Model 5) as in
Hall, Jaffe, and Trajtenberg (2005) and Noel and Schankerman (2013); the Fama-French four factor model plus an efficient factor based on the efficient minus
inefficient portfolio (Model 6) as in Hirshleifer, Hsu, and Li (2013); the Hou, Xue and Zhang (2015) q-factor model (Model 7); and the Stambaugh and Yuan
(2017) mispricing factor model (Model 8). The definitions of these factors can be found in Section 3.2. The sample period for portfolio returns is from February
2000 to December 2014. Newey-West adjusted t-statistics are provided in parentheses.
Panel A: Conditional on R-squared
Low 1.48% 1.06% 1.17% 1.07% 1.08% 1.11% 1.30% 1.24%
Middle 1.02% 0.56% 0.48% 0.49% 0.52% 0.52% 0.70% 0.69%
High 0.65% 0.25% 0.10% 0.18% 0.21% 0.20% 0.34% 0.40%
High-Low -0.83% -0.81% -1.07% -0.90% -0.87% -0.92% -0.97% -0.85%
t-stat (-2.05) (-2.26) (-3.04) (-2.51) (-2.47) (-2.64) (-2.50) (-2.01)
Panel B: Conditional on price delay

Low 0.74% 0.33% 0.22% 0.27% 0.29% 0.33% 0.38% 0.46%
Middle 1.03% 0.72% 0.64% 0.67% 0.70% 0.68% 0.92% 0.88%
High 1.58% 0.96% 0.97% 0.95% 0.98% 0.99% 1.10% 1.10%
High-Low 0.84% 0.63% 0.75% 0.69% 0.69% 0.65% 0.71% 0.65%
t-stat (2.40) (1.96) (2.27) (2.16) (2.15) (2.16) (1.75) (1.61)
44

Table 9: Cumulative abnormal returns
In this table, we provide the stock market’s reaction to the patent litigation from 2000 through 2014, with the event date representing the court filing date. We
provide the cumulative abnormal returns (CAR) of a stock in an event window [-n, m] starting from n days before the disclosure day (day 0) to m days after the
disclosure day. CAR1 is defined as the cumulative daily returns in excess of the CRSP value-weighted market index in the period; CAR 2 is defined using a
market model (estimated over the 150 trading-day period from days -171 through -22, and requiring at least 100 non-missing observations) with the CRSP value-
weighted market index as the benchmark; CAR3 is defined using a Fama-French four-factor model. We examine the following two event windows: [-1, 1] and [-
3, 3]. Panel A provides results for any public firm in our sample, and Panel B restricts the sample to lawsuits where there is at least one public plaintiff and one
public defendant. For each firm involved in any patent litigation case, we assign its CAR to the Plaintiff group if it is a plaintiff in the case and to the Defendant
group if it is a defendant in the case. We include all CARs in the Both group. We report the mean and the t-statistic of the mean being significantly different from
zero. We also provide the number of patent litigation cases in each group (NCASE), and the number of all stock-case observations in each group (NSTOCK). *,
**, and *** denote significant differences from zero for the mean value (t-test) in Panels A and B, and the significant difference of the correlation coefficient
from zero in Panel C, at the 10%, 5%, and 1% levels, respectively.
45

Panel A: Full sample
CAR1 CAR2 CAR3

Window Statistics Plaintiff Defendant Both Plaintiff Defendant Both Plaintiff Defendant Both
[-1, 1] Mean 0.11% 0.17%** 0.15%** 0.11% 0.12% 0.12%** 0.13% 0.07% 0.10%
t-stat (1.08) (2.01) (2.27) (1.22) (1.49) (1.96) (1.45) (0.90) (1.63)
[-3, 3] Mean 0.19% 0.11% 0.15%* 0.23%* 0.10% 0.16%* 0.21% 0.02% 0.10%
t-stat (1.43) (0.96) (1.72) (1.77) (0.89) (1.88) (1.64) (0.20) (1.24)
NSTOCK 8,906 8,672 17,578 8,845 8,575 17,420 8,834 8,565 17,399
NCASE 3,116 2,837 4,721 3,099 2,810 4,695 3,096 2,809 4,694
Panel B: Both plaintiffs and defendants being public
CAR1 CAR2 CAR3

Window Statistics Plaintiff Defendant Both Plaintiff Defendant Both Plaintiff Defendant Both
[-1, 1] Mean 0.15% 0.07% 0.11% 0.18% 0.07% 0.12% 0.20% -0.03% 0.08%
t-stat (1.10) (0.66) (1.30) (1.34) (0.64) (1.44) (1.48) (-0.23) (0.88)
[-3, 3] Mean 0.29% 0.03% 0.16% 0.33%* 0.12% 0.22%* 0.31%* -0.05% 0.12%
t-stat (1.53) (0.19) (1.24) (1.77) (0.69) (1.76) (1.67) (-0.29) (0.92)
NSTOCK 3,431 3,502 6,933 3,409 3,470 6,879 3,405 3,460 6,865
NCASE 1,542 1,558 1,868 1,533 1,545 1,864 1,531 1,544 1,864
46

Table 10: Tests of a risk explanation for litigation
This table presents tests of litigation as a risk factor. We use the excess return of the litigation portfolio from Table 1
as the litigation risk factor. We test if this factor exists in a linear stochastic discount factor model by implementing
a two-pass procedure (see Cochrane (2001)). First, we conduct a rolling window estimation to estimate the beta
associated with the litigation risk, βi,Litigation, for a test asset i (either a firm or a portfolio) using its stock returns in the
most recent 60 or 12 months. For example, for test asset i in month t, we estimate its βi,Litigation,t by regressing its
monthly excess returns on the litigation factor and other factors (MKT, SMB, and HML) from month t-59 (or t-11)
to month t. In particular, we obtain the betas from the market factor (βMKT), size factor (βSMB), and value factor
(βHML). Then, we conduct a cross-sectional regression for each month: for each month in our sample period, we
regress the monthly excess returns of all test assets on the litigation betas of all test assets (and other betas, such as
market betas) to calculate the coefficient on the litigation betas for the month. The coefficient on the litigation beta
serves as an estimate of litigation risk premium (known as “lambda”) in the month. Lastly, we test the significance
of the litigation risk premium by the time series mean and standard deviation of the coefficients on litigation betas
across all months and report the results in this table. We use individual firms as test assets. Panel A presents results
with 60-month estimates of beta, and Panel B presents results with 12-month estimates of beta. T-statistics based on
Newey-West adjusted standard errors are provided in parentheses.
Panel A: 60-month estimate of beta
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Intercept 0.008 0.009 0.009
(1.96) (2.11) (2.08)
βMkt 0.001 0.001 0.006 0.006
(.49) (0.27) (1.46) (1.45)
βLitigation 0.000 0.000 0.000 0.006 0.006 0.006
(0.11) (-0.10) (0.00) (1.15) (1.17) (1.14)
βSMB -0.001 0.001
(-1.22) (0.44)
βHML 0.003 0.003
(3.09) (3.59)
Observations
3,123 3,123 3,123 3,123 3,123 3,123
Adjusted R2 1.30% 1.73% 1.17% 10.01% 10.57% 9.84%
47

Panel B: 12-month estimate of beta
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6

Intercept 0.009 0.009 0.009
(1.89) (1.91) (1.78)
βMkt 0.000 0.000 0.004 0.004
(0.23) (0.27) (1.34) (1.33)
βLitigation 0.001 0.001 0.001 0.006 0.006 0.006
(0.33) (0.43) (0.38) (1.43) (1.46) (1.38)
βSMB -0.001 0.000
(-1.19) (0.43)
βHML 0.001 0.002
(1.70) (1.65)
Observations
4,169 4,169 4,169 4,169 4,169 4,169
2
Adjusted R 1.49% 1.78% 1.20% 8.19% 8.35% 7.91%
48

Table 11: Portfolio analysis conditional on financial constraints and cash holding
In Panels A and B, the sorting is based on the Kaplan-Zingales index; in Panels C and D, the sorting is based on cash and marketable securities scaled by lagged
total assets. Panels A and C (B and D) include all litigants (only defendants) in the sample. In this table, we provide the mean excess returns and t-statistics
(Newey-West t-statistics are provided in parentheses) of various portfolios, conditional on financial constraints and cash. In each month from January 2000 to
November 2014, we form three portfolios by assigning all firms involved in any patent litigation case in the past 12 months into three groups: the Low group
includes firms below the 30 th percentile, the Middle group includes firms between the 30th and 70th percentiles, and the High group includes firms above the 70 th
percentile. We then hold these portfolios and track the equal-weighted return on these portfolios for the next month. We also form the High-Low portfolio by
taking a long position in the High portfolio and a short position in the Low portfolio. We provide the unadjusted excess returns in Model 1 and consider the
following seven additional models: the Fama-French four-factor model with MKT, SMB, HML and momentum factor UMD (Model 2); the Fama-French four
factor plus profitability factor RMW and investment factor CMA (Model 3) as in Fama and French (2015); the Fama-French four factor plus a R&D factor based
on R&D expense divided by ME (Model 4) as in Chan, Lakonishok, and Sougiannis (2001) and Lev, Sarath, and Sougiannis (2005); the Fama-French four factor
plus a patent factor based on the number of patents divided by total assets (Model 5) as in Hall, Jaffe, and Trajtenberg (2005) and Noel and Schankerman (2013);
the Fama-French four factor model plus an efficient factor, based on the efficient minus inefficient portfolio (Model 6) as in Hirshleifer, Hsu, and Li (2013); the
Hou, Xue and Zhang (2015) q-factor model (Model 7); and the Stambaugh and Yuan (2017) mispricing factor model (Model 8). The definitions of these factors
can be found in Section 3.2. The sample period for portfolio returns is from February 2000 to December 2014.
Panel A: Conditional on financial constraints (all litigants)

Low 1.03% 0.77% 0.67% 0.73% 0.75% 0.76% 0.98% 1.00%
Middle 0.96% 0.48% 0.40% 0.44% 0.47% 0.45% 0.53% 0.47%
High 1.30% 0.80% 0.87% 0.76% 0.79% 0.81% 0.99% 1.03%
High-Low 0.27% 0.04% 0.20% 0.03% 0.04% 0.05% 0.02% 0.03%
t-stat (0.93) (0.15) (0.69) (0.13) (0.15) (0.18) (0.08) (0.13)
Panel B: Conditional on financial constraints (defendants only)

Low 0.76% 0.48% 0.60% 0.40% 0.42% 0.48% 0.76% 0.82%
Middle 1.17% 0.69% 0.62% 0.66% 0.69% 0.70% 0.79% 0.79%
High 0.98% 0.44% 0.47% 0.41% 0.43% 0.43% 0.69% 0.68%
High-Low 0.21% -0.04% -0.13% 0.01% 0.01% -0.05% -0.07% -0.14%
t-stat (0.55) (-0.11) (-0.32) (0.04) (0.03) (-0.14) (-0.21) (-0.39)
49

Panel C: Conditional on cash balance (all litigants)
Low 0.98% 0.38% 0.13% 0.38% 0.39% 0.39% 0.41% 0.48%
Middle 1.19% 0.72% 0.70% 0.68% 0.71% 0.71% 0.80% 0.75%
High 0.96% 0.73% 0.79% 0.66% 0.69% 0.71% 0.99% 0.99%
High-Low -0.02% 0.36% 0.66% 0.28% 0.30% 0.33% 0.58% 0.51%
t-stat (-0.04) (1.11) (1.88) (0.86) (0.93) (1.03) (1.44) (1.34)
Panel D: Conditional on cash balance (defendants only)

Low 0.77% 0.15% -0.09% 0.18% 0.19% 0.19% 0.19% 0.26%
Middle 1.01% 0.56% 0.49% 0.54% 0.56% 0.57% 0.70% 0.74%
High 1.13% 0.80% 1.08% 0.68% 0.73% 0.79% 1.09% 0.99%
High-Low 0.36% 0.64% 1.17% 0.50% 0.53% 0.60% 0.90% 0.73%
t-stat (0.63) (1.51) (3.16) (1.22) (1.38) (1.48) (1.92) (1.57)
50

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So Sue Me!

Patent Litigation and the Cross-section of Stock Returns‡

Fred Bereskin*, Po-Hsuan Hsu**, William Latham***, Huijun Wang†

JEL classification: G12, G14, O34

Electronic copy available at: https://ssrn.com/abstract=3090551

We then adopt a calendar-time portfolio approach and create a monthly-rebalanced stock

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Electronic copy available at: https://ssrn.com/abstract=3090551

Electronic copy available at: https://ssrn.com/abstract=3090551

Electronic copy available at: https://ssrn.com/abstract=3090551

Electronic copy available at: https://ssrn.com/abstract=3090551

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Electronic copy available at: https://ssrn.com/abstract=3090551

2. Sample and summary statistics

Electronic copy available at: https://ssrn.com/abstract=3090551

When evaluating the effects of patent litigation, it is important to recognize the

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3.1. Portfolio analysis for the returns in the subsequent 12 months

We use such a calendar-time portfolio instead of an event-time portfolio, as the latter

Electronic copy available at: https://ssrn.com/abstract=3090551

In order to consider various systematic risk or other potential explanatory factors in

In Models 4 to 6, we add each of the following innovation-related factors to Model 2: an

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Consequently, we use Tables 2 and 3 to confirm the robustness of a positive litigation-

3.2. Fama-MacBeth cross-sectional regressions for returns

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We find that the litigation-related variable (DUMMY_CASE) is positive in all

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4.1. Potential benefits from patent litigation

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4.2. Undervaluation due to information delay

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4.3. Systematic risk related to patent litigation

In this section, we provide additional analyses to examine if the return predictability

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4.4. Systematic risk related to financial constraints

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4.5. Cash holdings

In Panel C of Table 11, we consider an important driver of litigation—cash—that may

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Plantiff Defendant Both

Plantiff Defendant Both

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Panel A: Full sample

Fred Bereskin, Po-Hsuan Hsu, William Latham, Huijun Wang†