How Does the Primary Market Value Innovations of Newly Public Firms?

Abstract

We investigate whether and how the primary market values the innovations of newly public firms at their initial public offerings (IPOs) by examining the link between the size (the number of patents) and the quality (citation count) of their patent portfolios and IPO valuations. We find that the number of patents, the citation count, and innovation efficiency (IE; patents or citations scaled by research and development expenditure) are positively associated with offer price multiples but the effect of the number of patents subsumes that of the citation count/IE. There is no significant effect of patent portfolios on price revisions or first-day returns, suggesting that underwriters/firms price information on innovation quantity and quality in the offer prices and the market makes no further price adjustment on innovation information. The positive effect of innovation quantity on IPO valuation subsumes that of innovation quality. We also demonstrate that the link between patent portfolios and IPO valuations is stronger in the later sample period. Using Tobin’s Q as another IPO valuation measure produces similar results. We obtain no evidence that an IPO’s patent portfolio is overvalued in the primary market, as the number of patents and the citation count are not significantly associated with long-run stock and operating performances.