What is the Value of an Innovation? Theory and Evidence on the Stock Market's Reaction to Innovation Announcements

Abstract

We analyze, theoretically and empirically, the effect of investor attention on the stock market reaction to innovation announcements and suggest how market-based measures of the economic value of patents can be enhanced. We develop a dynamic model with limited investor attention to show that, following the immediate market reaction to innovation announcements, there will also be a stock return drift: the magnitude of the announcement effect will be increasing while that of the post-announcement drift will be decreasing in investor attention. We test our model predictions using two different datasets: a matched sample of pharmaceutical industry patent grant and subsequent FDA drug approval announcements; and a general USPTO sample of patent grant announcements. We use the media coverage of innovation announcements as a proxy for the investor attention paid to them. Consistent with model predictions, we find the following. First, in our matched patent grant and drug approval analysis, the announcement effects of patent grant announcements are smaller than those of FDA drug approval announcements; the subsequent stock return drifts, however, are larger for patent grant announcements. Second, the announcement effect of patent grant announcements is increasing in investor attention while the subsequent stock return drift is decreasing in investor attention. Third, the stock-return drift following patent grant announcements has predictive power for the economic value of patents, over and above the information contained in the announcement effect. Finally, we show that a long-short trading strategy based on investor attention is profitable over the one-month period after patent grant announcements.