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E-MailThis paper comes to us from Josh Lerner, Professor of Finance at Harvard Business School; Morten Sørensen of the Finance Department at Columbia University; and Per Strömberg of the Finance Department at the University of Chicago and the Stockholm School of Economics.
In the paper Private Equity and Long-Run Investment: The Case of Innovation, forthcoming in the Journal of Finance, we examine the changes in patenting behavior of 495 firms with at least one successful patent application filed in the period from three years before to five years after being part of a private equity transaction. A long-standing controversy is whether LBOs relieve managers from short-term pressures from public shareholders, or whether LBO funds themselves are driven by short-term profit motives and sacrifice long-term growth to boost short-term performance.
Our main finding is that firms pursue more influential innovations, as measured by patent citations, in the years following private equity investments. Firms display no deterioration in their research, as measured either by patent “originality” and “generality,” and the level of patenting does not appear to change after these transactions. We find some evidence that the patent portfolios become more focused in the years after private equity investments. The increase in patent quality is greatest in the patent classes where the firm has been focused historically and in the classes where the firm increases its patenting activity after the transaction. The patterns are robust to a variety of specifications and controls. Collectively, these findings are largely inconsistent with the hypothesis that private equity-backed firms sacrifice long-run investments. Rather, private equity investments appear to be associated with a beneficial refocusing of firms’ innovative portfolios.
One limitation is that we cannot formally distinguish whether private equity investors cause these changes or selectively invest in firms that are ripe for an increase in innovative activity. We do not have an instrumental variable to help us resolve the causation question. However, our findings related to the timing of the changes and the predominantly “old economy” nature of the firms in our sample suggest that selection plays a relatively minor role in our results.
The full paper is available for download here.
2 Comments
Beautiful work, which raises many interesting questions at the same time it answers some important ones. Was there any way to check to see whether or how much R&D expenditures pre- and post-LBO were cross-correlated with your quality metrics? But perhaps there wouldn’t be much as the engineering salaries wouldn’t usually be expensed as capital. The debt load that results from an LBO could iteself be part of the ambiguous causality of low R&D to debt for larger corps.
Fascinating paper, and obviously the result of lots of careful work. Kudos.
Interesting paper especially as I’m an active investor/trader and have long believed that some companies create the illusion of value in a market where share price is increasingly mistaken for earnings.