Journal of Banking and Finance 148 (2023) 106740

Contents lists available at ScienceDirect

Journal of Banking and Finance

journal homepage: www.elsevier.com/locate/jbf

So Sue Me! The cross section of stock returns related to patent

infringement allegations✰
Fred Bereskin a, Po-Hsuan Hsu b,∗, William Latham c, Huijun Wang d
a
Trulaske College of Business, University of Missouri, Columbia MO 65211, USA
b
National Tsing Hua University, Hsinchu, Taiwan
c
University of Delaware
d
Auburn University, Auburn AL 36849, USA

a r t i c l e i n f o a b s t r a c t

Article history: Using patent lawsuit data from 20 0 0 to 2014, we find that a stock portfolio consisting of alleged patent
Received 17 November 2020 infringers (i.e., firms sued for patent infringement) provides significantly higher stock returns (between
Accepted 29 November 2022
0.48% to 0.61% per month) in the following year compared to other firms with similar characteristics. In
Available online 5 December 2022
contrast, plaintiff firms’ subsequent stock returns are not significantly different from comparable firms’
JEL classification: returns. We examine several possible explanations for this pattern, including pessimism-driven mispric-
G12 ing, exposure to unknown systematic risk, cash holdings, and financial constraints. Our evidence supports
G14 the explanation based on pessimism-driven mispricing.
O34 © 2022 Elsevier B.V. All rights reserved.

Keywords:
Patent litigation
Stock returns
Mispricing
Pessimism
Return predictability

1. Introduction frequent outcome of failed negotiation between litigants to address

Patent infringement and associated litigation has become a
challenging issue for firms, managers, and shareholders in today’s
business environment where intellectual property plays a critical
role (Jaffe and Lerner, 2004). Lanjouw and Schankerman (2004) re-
port that in the U.S. between 1978 and 1995, 2% of patents were
subject to patent litigation. In some sectors, such as biotechnology,
this percentage can be as high as 6%. Lemley et al. (2019) use sur-
vey data to show that approximately one-third of alleged infringe-
ment results in litigation. This indicates that litigation is not an in-
✰ tential indirect costs including reduced pledgeability (Chava et al.,
We thank Dan Bereskin, Jim Bessen, Lauren Cohen, Jarrad Harford, Sima Jan-
nati, Edwin Lai, Haitian Lu, Don MacOdrum, Michael Meurer, Zhenjiang Qin, Avri
Ravid, Ghon Rhee, Ryan Whalen, Angela Zhang, Shu Zhang, and Tong Zhou, as
well as seminar participants at the 2018 FMA Conference, University of Guelph,
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. Hsu acknowledges financial support from the Ministry of Science and Technol-
ogy and the Ministry of Education in Taiwan (MOST109–2628-H-0 07–0 01-MY4 and
MOE110J0321Q2).
∗
Corresponding author.
E-mail address: pohsuanhsu@mx.nthu.edu.tw (P.-H. Hsu).
potential infringement.
Compared to the 1980s and earlier, firms are now more likely
to be sued for patent infringement (United States Government Ac-
countability Office, 2013; Cohen et al., 2016a,b, 2019). The increas-
ingly litigious environment has exposed firms to significant di-
rect and indirect litigation costs for patent lawsuits. For exam-
ple, the American Intellectual Property Law Association (2015) re-
ports that patent litigation tends to be costly and time-intensive.
Specifically, they note that the median patent infringement suit ex-
periences litigation costs ranging from $10 0,0 0 0 (when less than
$1 million is at risk) to $5 million (when more than $25 mil-
lion is at risk). Aside from these direct costs, we also note po-
2017; Mann, 2018) or reduced selling price of intellectual prop-
erty (Lev, 2001). Akcigit et al. (2016) note that 20% of domestic
patents are sold. Other indirect costs include distractions to man-
agement, difficulties in ensuring long-run commitments with sup-
pliers and customers (Tucker, 2014), difficulties in attracting fi-
nancing (Feldman, 2014), and delays in implementing innovation
and marketing strategies.
In this study, we attempt to examine the asset pricing im-
plications of patent infringement litigation. We are interested in

https://doi.org/10.1016/j.jbankfin.2022.106740
0378-4266/© 2022 Elsevier B.V. All rights reserved.
F. Bereskin, P.-H. Hsu, W. Latham et al.
this question for two reasons: First, as prior studies suggest that
stock markets react negatively to news about patent infringement
litigation within a one month window (e.g., Bhagat et al., 1994;
Lerner, 1995; Bessen and Meurer, 2012), whether alleged infringers’
subsequent stock returns remain negative or reverse in the long
run (i.e., the subsequent 12 months) is important for understand-
ing how firms are affected by the litigation. Second, the mecha-
nism for the stock market reaction is not clearly understood from
prior research using event studies. Consequently, in our study we
use a calendar-time portfolio approach that is tradable and allows
us to implement various asset pricing tests to understand the un-
derlying mechanisms.
To examine the asset pricing implications of patent infringe-
ment litigation, we first collect patent lawsuits involving public
firms from the Lex Machina database, which covers patent litiga-
tion cases filed since 20 0 0. Lex Machina is regarded as the most
comprehensive database of U.S. patent lawsuits and has been used
in many recent studies (Akcigit et al., 2016; Allison et al., 2015;
2018; Cohen et al., 2016b, 2019). We then combine the patent liti-
gation data with the CRSP/Compustat databases to collect a list of
alleged infringers that are sued for patent infringement by publicly
listed firms that are not non-practicing entities (so-called “patent
trolls”) between 20 0 0 and 2014.
We use propensity score matching (PSM) to match alleged in-
fringers with similar firms and examine the difference in their sub-
sequent stock returns. In each month, for each alleged infringer
that is sued for patent infringement in the prior 12 months, we
find a matched control firm with the same SIC 2-digit industry
code with the closest distance in size, book-to-market ratio, mo-
mentum, and number of patents over the past ten years. We then
construct a portfolio of alleged infringers and a portfolio of control
firms and track their value-weighted stock returns. When we take
a long position in the former and a short position in the latter,
we find that this long-short portfolio’s monthly returns average to
0.55% (or 6.60% per year) in the 20 0 0–2014 period. We also imple-
ment Fama-MacBeth regressions to control for various firm char-
acteristics. We find that alleged infringers’ stock returns are sig-
nificantly higher than other firms. Our tests suggest that alleged
infringers’ higher stock returns cannot be explained by systematic
risk and firm characteristics.
In contrast, we find that plaintiffs’ stock returns are insignifi-
cantly different from zero. This suggests that plaintiffs’ litigation
information has been correctly embedded in their stock prices and
that these firms are not subject to systematic risk exposure.
To understand the return predictability related to patent in-
fringement, we propose and empirically examine the following ex-
planations. First, as firms’ stock prices drop on the news of be-
ing sued for patent infringement (Bhagat et al., 1994; Lerner, 1995;
Bessen and Meurer, 2012), stock investors could be excessively pes-
simistic about infringement charges and thus over-discount the
prices of alleged infringers. Tetlock (2007) provides empirical ev-
idence for the prevalence of investors’ and the media’s excessive
pessimism that downwardly impact stock prices; however, such an
impact is reversed later. In addition, Garcia (2013) finds that stock
markets are more sensitive to pessimistic sentiment during reces-
sions, which highlights the stronger effect of pessimism during os-
tensibly challenging periods. These findings are consistent with the
“negativity bias” from the psychology literature, which describes
the phenomenon that bad news is more impactful than good news
because the former is processed faster and leaves stronger impres-
sions among affected individuals (see Baumeister et al. (2001) and
Rozin and Royzman (2001)). Such pessimism is also likely to hap-
pen to alleged infringers because investors tend to be overly pes-
simistic about innovation-related news (Lev and Sougiannis, 1996;
Chan et al., 2001; Eberhart et al., 2004), possibly due to uncer-
tainty aversion and/or lack of ability in processing complex infor-
2
Journal of Banking and Finance 148 (2023) 106740
mation related to patents (Cohen et al., 2013; Hirshleifer et al.,
2013; 2018).
Second, firms sued for patent infringement could be exposed
to an unknown systematic risk associated with patent competition
and/or litigation, and thus provide higher expected stock returns as
risk compensation. Third, firms that are cash-rich are more likely
to be sued (Cohen et al., 2019; Lee et al., 2021); thus, our findings
could capture a pattern of cash-rich defendants providing greater
subsequent profits and stock returns. Finally, firms experiencing fi-
nancial constraints might be especially vulnerable to the patent
litigation process. Consequently, more financially constrained de-
fendants could be associated with higher expected returns as risk
compensation (Li, 2011).
Our test results are most supportive of the excessive pessimism
explanation. We find that alleged infringers’ stock returns are
higher when these stocks are subject to greater mispricing. We
then propose to measure investors’ excessive pessimism using a
stock’s negative cumulative earnings announcement returns (nor-
malized by the negative analyst forecast error divided by stock
price). The idea behind this proxy is that a relatively larger stock
price decline following an unsatisfactory earnings announcement
would generally reflect more pessimism among investors (e.g.,
Garcia, 2013). We find that alleged infringers’ stock returns in-
crease with investors’ pessimism. Further tests suggest that the
higher returns of alleged infringers cannot be attributed to un-
known systematic risk factors related to patent litigation. Finally,
we show that alleged infringers’ stock returns are unrelated to
firms’ cash holdings and financial constraints, which does not sup-
port explanations based on a cash motive or risk related to finan-
cial constraints.
We also examine the future competition status and operating
performance of alleged infringers. Our results suggest that alleged
infringers experience less industry competition and become more
profitable in the three- or five-years following litigation. These
findings are consistent with prior studies arguing that patent in-
fringement litigation highlights the barriers to entry associated
with their businesses—thus deterring potential competitors—and
reflects the profits to be earned from alleged infringers’ use of
plaintiffs’ intellectual property.1
Our paper contributes to the finance literature in the follow-
ing dimensions. First, in contrast to prior studies on behavioral bi-
ases that focus on overconfidence and optimism, we use patent in-
fringement litigation to highlight excessive pessimism due to hu-
man beings’ negativity bias (Baumeister et al., 2001; Rozin and
Royzman, 2001). Such a behavioral bias is relatively underex-
plored with the exception of papers such as Tetlock (2007) and
Garcia (2013), who focus on aggregate market sentiment. In ad-
dition, our empirical results echo evidence from prior research
on the difficulty of precisely evaluating news related to patents
(Cohen et al., 2013; Hirshleifer et al., 2013; 2018).
Second, we focus on the pricing effect of patent infringement
litigation initiated by publicly listed practicing entities (“PEs”),
which is distinct from prior studies that mainly focus on aggre-
gate innovation (Hobijn and Jovanovic, 2001; Laitner and Stol-
yarov, 2003; Pástor and Veronesi, 20 09; Hsu, 20 09; Garleanu et al.,
2012) or firms’ own technological development (Lin, 2012;
Peters and Taylor, 2017; Bena and Garlappi, 2020). Our study thus
provides new insights into the asset pricing implications of tech-
nological competition.2
1
Indeed, prior research (e.g., Cohen, Gurun, and Kominers, 2016a,b, 2019;
Caskurlu, 2019) has highlighted how patent litigation changes firms’ behaviors.
2
Gu (2016) shows that competition and R&D investments have a strong interac-
tion effect on the cross-section of stock returns, and Hsu, Lee, and Zhou (2022) find
that patent thickets (i.e., fragmented patent ownership) deter firms’ commercializa-
tion of their patents and thus reduce their expected stock returns.
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

Finally, compared to prior studies’ focus on stock markets’ im- least one public firm, which includes those without court decisions
mediate responses to patent litigation news (Bhagat et al., 1994; or out-of-court settlements.4
Lerner, 1995; Bessen and Meurer, 2012), we adopt a calendar-time When evaluating the effects of patent litigation, it is important
portfolio approach that is tradable and allows various asset pricing to recognize the differences between practicing entities (PEs, i.e.,
tests to better identify the underlying mechanism of return pre- firms that commercialize their patents to make profits) and non-
dictability. practicing entities (NPEs, or “patent trolls”). Evidence suggests that
We organize our paper as follows. In Section 2, we present PEs’ patent litigation has not increased at the same rate as that
our sample construction and summary statistics. In Section 3, we of NPEs. A great deal of litigation with PEs involves inadvertent
describe our main results for return predictability. In Section 4, infringement (Bessen and Meurer, 2013) and, more generally, is
we examine possible explanations for the return predictability. We driven by the actual infringement itself, as opposed to being driven
then examine the relation between patent infringement litigation by exploiting the profitability of potential lawsuits (Cohen et al.,
and future profitability and market competition in Section 5. We 2016b, 2019). Nevertheless, Bessen et al. (2018) find no difference
conclude this paper with Section 6. in announcement effects for PE- and NPE-lawsuits (after they in-
clude their control variables).
We focus on litigation between PEs, and exclude all lawsuits
2. Sample and summary statistics
related to patent trolls. We manually identify litigants that are
not manufacturers, universities, government entities, or non-profit
To construct a dataset for our analysis, we first collect patent
firms, and also identify firms whose activities are classified as in-
lawsuits relating to public firms’ patents by combining the patent
tellectual property consulting according to Google search results.
database of public firms (available until 2014) and the Lex Machina
By merging this list with the sample of public patent trolls used by
database for patent litigation (available since 20 0 0). It is important
Bessen et al. (2011), we construct a list of NPEs that we use to filter
to note that this database only includes cases that were actually
out NPE-related cases.5 For brevity, we use the term “patent litiga-
filed (i.e., where both plaintiffs and defendants did not agree to
tion” to describe the event that a public firm is sued for patent
settle their disputes before the initiation of formal litigation). We
infringement over another public firm’s patents.
begin by constructing a list of 1,609,059 patents that were granted
For each patent litigation lawsuit unrelated to NPEs, we manu-
to public firms from 1983 to 2014 by combining the NBER patent
ally match the defendant names to the corresponding GVKEY and
dataset (originally developed by Hall et al. (2001)), the patent
PERMNO in the CRSP and Compustat databases that include all fi-
dataset of Kogan et al. (2017), and the Google Patent database.
nancial and accounting data of publicly listed firms in the U.S. We
The updated NBER patent dataset contains the patent number, ap-
further collect these firms’ financial data from CRSP and their ac-
plication date, grant date, and Compustat firm identifier GVKEY
counting data from Compustat. We exclude financial firms with SIC
of the patent assignee (i.e., the firm that owns the patent) of all
codes between 60 0 0 and 6999 and utility firms with SIC codes be-
utility patents granted to public firms from 1976 to 2006. Kogan
ginning with 49. We then merge patent litigation data with the
et al.’s patent database includes the patent number, application
CRSP/Compustat database to construct a sample of firm-year ob-
date, grant date, and Center for Research in Security Prices (CRSP)
servations of all public firms being sued for patent infringement.
firm identifier (PERMNO) of the patent assignee of each utility
patent granted to public firms from 1926 to 2010. Lastly, we use
the Google Patent database to extend the patent data to all patents
3. Empirical results
granted by 2014.3 We use court filing dates to construct our port-
folio to ensure that the information is timely and publicly avail-
3.1. Subsequent stock returns on portfolios of alleged infringers and
able; Bessen and Meurer (2012) note that not all lawsuits are pub-
control firms
licly disclosed by the firm (or noted in the media), and that there
is sometimes a delay between the court filing date and the an-
To examine if patent infringement litigation explains stock re-
nouncement date by the firm/media.
turns, we adopt a calendar-time portfolio approach: At the end
We start our patent list with the 1983 grant year because
of every month t, from January 20 0 0 to November 2014, we use
patents were valid for 17 years from the grant date at that time,
propensity score matching (PSM) to find treated and control firms
and the Lex Machina database is available from 20 0 0 (since June
and construct portfolios accordingly. Specifically, in each month
8, 1995, patents are valid for 20 years from their application date).
we collect a list of firms that were sued for patent infringement
Then, we use this list of 1,609,059 patents in our search in the
within the previous 12 months (i.e., alleged infringers). For each
Lex Machina database, which includes patent litigation court filings
alleged infringer in each month, we match it with another firm
since 20 0 0. In establishing its database, Lex Machina cleaned and
(i.e., control firm) with the same SIC 2-digit industry code that has
verified daily updates from the United States federal court system,
the closest distance in size, book-to-market, momentum, and the
all United States district courts, the United States International
number of patents over the past ten years (using a caliper of 0.2).
Trade Commission database (EDIS), and the USPTO. Lex Machina
In Panel A1 of Table 1, we report summary statistics (mean, stan-
is regarded as the most comprehensive database of U.S. patent
dard deviation, median, and first/third quartiles) for all variables in
litigation since 20 0 0. Other recent studies have used data from
our firm-year observations for alleged infringers. The mean (me-
Lex Machina (Akcigit et al., 2016; Allison et al., 2015; J.R. 2018;
dian) alleged infringer experiences 1.5 (1) lawsuits per year. Panel
Cohen et al., 2016b, 2019). We derive a list of 9343 patent infringe-
A2 presents summary statistics for all variables in our firm-year
ment lawsuits in which the involved patents were granted to at
observations for matched control firms.

3
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 as-
signees 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.
4
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 re-
sult in settlements (68%), non-merit dispositions (20%), or summary judgments and
dismissals with prejudice (9%).
5
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).

3
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

Table 1
Summary statistics.
This table reports the sample distribution of the firm-year observations for our sample from 20 0 0 to 2014. Panel A1 provides sample statis-
tics for alleged infringers, and Panel A2 provides sample statistics for the matched control firms for alleged infringers. Panel B1 provides
sample statistics for plaintiffs, and Panel B2 provides sample statistics for the matched control firms for plaintiffs. The related variables we
consider include: the number of patent lawsuits over the past 12 months (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 as-
sets (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), and 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). All values (aside from NCASE and RET) are winsorized
at the 1% and 99% levels.

Panel A1: Alleged infringers

N Mean STD 25th percentile Median 75th percentile

NCASE 15,149 1.53 1.98 1.00 1.00 1.00

RET 15,149 0.01 0.15 −0.06 0.01 0.07
BM 15,149 0.55 0.63 0.24 0.40 0.64
ME 15,149 9358 23,752 528 1971 6932
XRD 15,149 0.19 0.24 0.04 0.13 0.27
NPATENT 15,149 0.03 0.08 0.00 0.01 0.03
MOM11 15,149 16.69 63.49 −16.64 8.50 35.81
MOM36 15,149 37.29 126.68 −23.85 11.55 57.95
INV 15,149 0.17 0.50 −0.02 0.07 0.21
OP 15,149 0.20 0.45 0.10 0.21 0.34

Panel A2: Matched control firms for alleged infringers

N Mean STD 25th percentile Median 75th percentile

NCASE 15,149 0.00 0.00 0.00 0.00 0.00

RET 15,149 0.02 0.14 −0.05 0.01 0.07
BM 15,149 0.56 0.67 0.24 0.39 0.65
ME 15,149 8784 21,155 534 1974 6963
XRD 15,149 0.18 0.26 0.00 0.09 0.24
NPATENT 15,149 0.03 0.08 0.00 0.01 0.03
MOM11 15,149 17.30 55.78 −11.87 10.31 35.36
MOM36 15,149 37.98 145.72 −21.11 13.57 56.90
INV 15,149 0.15 0.59 −0.02 0.06 0.17
OP 15,149 0.20 0.50 0.11 0.22 0.34

Panel B1: Plaintiffs

N Mean STD 25th percentile Median 75th percentile

NCASE 13,455 1.71 1.96 1.00 1.00 2.00

RET 13,455 0.01 0.16 −0.06 0.01 0.07
BM 13,455 0.48 0.46 0.23 0.36 0.57
ME 13,455 11,514 28,425 456 1914 7248
XRD 13,455 0.23 0.26 0.08 0.17 0.31
NPATENT 13,455 0.05 0.11 0.00 0.02 0.05
MOM11 13,455 18.59 84.93 −15.58 8.33 33.71
MOM36 13,455 36.74 128.50 −23.57 11.65 55.12
INV 13,455 0.19 0.58 −0.02 0.07 0.21
OP 13,455 0.16 0.54 0.09 0.21 0.32

Panel B2: Matched control firms for plaintiffs

N Mean STD 25th percentile Median 75th percentile

NCASE 13,455 0.00 0.00 0.00 0.00 0.00

RET 13,455 0.01 0.14 −0.06 0.01 0.07
BM 13,455 0.48 0.47 0.21 0.36 0.60
ME 13,455 10,105 24,833 439 1771 7499
XRD 13,455 0.26 0.35 0.06 0.15 0.32
NPATENT 13,455 0.05 0.14 0.00 0.02 0.05
MOM11 13,455 17.77 75.82 −14.94 8.69 34.53
MOM36 13,455 32.60 109.26 −23.93 13.19 57.97
INV 13,455 0.13 0.44 −0.03 0.06 0.17
OP 13,455 0.15 0.74 0.08 0.21 0.34

We then form a portfolio of alleged infringers that have
matched control firms (“the alleged infringer portfolio” hence-
forth), and a portfolio of control firms (“the control portfolio” here-
after). We track the value-weighted returns of these two portfolios
in the next month. We also construct a long-short portfolio by tak-
ing a long position in the alleged infringer portfolio and a short po-
sition in the control portfolio. We rebalance each portfolio at the
end of each month, and report the average return and alphas on
each portfolio in Table 2.6
6
As our portfolios are formed at the end of each month rather than court filing
dates (event dates), we note that their returns do not reflect stock markets’ im-
mediate reaction to patent litigation news (such as one- or three-day cumulative
abnormal returns). Instead, the returns better reflect long-term stock price move-
ments due to patent litigation in the subsequent 12 months. Thus, investors’ pay-
offs would not be sensitive to the announcement or news release dates of patent

4
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

To show how litigation intensity varies over time in our sample,

divided by ME (Model 4) as in Chan et al. (2001) and Lev et al. (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 et al. (2005) and Noel and
ratio, momentum, and the number of patents over the past ten years. In each month from January 20 0 0 to November 2014, we form the Alleged infringer portfolio including all firms (for which we can find matched control

Schankerman (2013); the Fama-French four factor model plus an efficient factor based on the efficient minus inefficient portfolio (Model 6) as in Hirshleifer et al. (2013); the Hou et al. (2015) q-factor model (Model 7); and
defendants in litigation cases in the past 12 months, and control firms are matched in the same year by 2-digit SIC codes that have patents over the past ten years and have the closest distance in size, book-to-market

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
firms) sued for patent infringement in the past 12 months. We also form the Control portfolio including all control firms. We then hold these two portfolios and track the value-weighted returns on these portfolios as well
as their differences 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
In this table, we provide the mean excess returns and t-statistics (Newey-West t-statistics are provided in parentheses) of portfolios based on patent litigation. The alleged infringer portfolio includes firms that have been
the upper panel of Fig. 1 provides the number of patent litigation
cases with public firms being sued for patent infringement by year

the Daniel, Hirshleifer, and Subramanuam (1998) DHS model (Model 8). The definitions of these factors can be found in Section 3.1. The sample period for portfolio returns is from February 20 0 0 to December 2014.
(we provide results both before and after implementing our PSM).

(−0.71)
−0.13%
We observe continuous growth in patent litigation cases for most

(2.32)

(2.40)
0.37%

0.50%
DHS
of our sample period. The number of cases peaks in 2012 with 187

(8)
observations (in the “after PSM” sample), and then gradually de-
clines. The decline in recent years may be attributed partly to the
Leahy-Smith America Invents Act, which reduces patent litigation
(e.g., Cohen et al., 2019). The lower panel of Fig. 1 provides the an-
nual numbers of firms/stocks, both before and after implementing
q-theory
4-factor

(−1.03)
−0.19%
our PSM.

(2.18)

(2.51)
0.39%

0.57%
In Model 1 of Table 2 we present the average monthly ex-
(7)

cess returns (i.e., monthly returns in excess of the one-month T-

bill rate) of the alleged infringer portfolio, the control portfolio,
and the long-short portfolio.7 The alleged infringer portfolio pro-
factor + Efficiency

vides an average monthly excess return of 68 basis points per

Fama-French 4-

month, which is significantly higher than the control portfolio with

an average monthly excess return of 13 basis points. The long-
(−1.31)
−0.21%

short portfolio has an average return of 55 basis points per month

(2.34)

(2.47)
0.41%

0.61%

(equivalent to 6.60% per year) with a t-statistic of 2.19; this esti-

(6)

mate is based on our sample period of 179 months (February 20 0 0

to December 2014).
To consider various systematic risks, we estimate the alphas of
Fama-French 4-
factor + Patent

the long-short portfolio based on different factor models in Models

2 to 8 in Table 2. In the Fama-French four-factor model (Model 2),
(−1.01)
−0.17%

(2.53)

(2.43)

the alpha is 61 basis points per month with a t-statistic of 2.50. Us-
0.43%

0.59%
(5)

ing the six-factor model of Fama and French (2015) that further in-
cludes the profitability factor RMW and the investment factor CMA
(Model 3), the alpha is 48 basis points per month with a t-statistic
of 1.92. Therefore, the significantly higher stock returns of alleged
4-factor + R&D
Fama-French

infringers cannot be explained by various systematic risks related

to firms’ size, book-to-market ratio, momentum, profitability, or in-
(−1.03)
−0.17%

(2.56)

(2.46)
0.41%

0.58%

vestment.
(4)

Models 4 to 6 add each of the following innovation-related fac-

tors to Model 2: An R&D factor, a patent factor, and an innovative
efficiency factor (their definitions are provided in the Appendix).
factor + RMW + CMA

The alphas from these models range between 58 and 61 basis

points per month and remain statistically significant, suggesting
Fama-French 4-

that our results are not explained by R&D- or patent-related risks.

Models 7 and 8 consider two newer factor models
−0.16%
(0.80)

(2.04)

(1.92)
0.32%

0.48%

and find even higher alphas: The q-theory factor model

(3)

of Hou et al. (2015) and the behavioral factor model of

The returns of two portfolios for alleged infringers and matched control firms.

Daniel et al. (2020). 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
Fama-French

behavioral factor model includes a market factor, a long-horizon

behavioral factor, and a short-horizon behavioral factor. The alphas
4-factor

(−1.01)
−0.16%

(2.63)

(2.50)
0.45%

0.61%

in the former and latter models are 57 and 50 basis points per
(2)

month with t-statistics of 2.51 and 2.40, respectively. Therefore,

the significantly higher stock returns of alleged infringers cannot
be attributed to investment-based risk or exposure to behavioral
factors.
No factor

3.2. Fama-MacBeth regressions

(0.32)

(1.83)

(2.19)
0.13%

0.68%

0.55%
(1)

There might be some concern that firms being sued for patent
infringement are fundamentally different from other firms and
Alleged infringer -
Control portfolio

Alleged infringer

litigation, which appear to be a critical issue for immediate market reactions within
return/alphas

one or three days (Bessen and Meurer, 2012).

portfolio

7
Our one-month T-bill rate and Fama and French factors are from the Kenneth
Control
Excess

t-stat

t-stat

t-stat
Table 2

French data library. The Hou, Xue, and Zhang q-factors are from Lu Zhang. The
Daniel, Hirshleifer, and Sun behavioral factors are from Kent Daniel’s website. We
thank Kenneth French for making the data publicly available, and thank Lu Zhang
for sharing the data with us.

5
F. Bereskin, P.-H. Hsu, W. Latham et al.
Fig. 1. Distribution of alleged infringers by year.
In this figure, we provide the number of cases in the upper panel (and number of stocks in the lower panel) of patent litigation defendants in each year. For both panels,
we provide results both before and after implementing our PSM. The PSM is described in greater detail in Section 3.1.
that our stock return findings are driven by heterogeneity in
firm characteristics. To address this concern, we consider Fama-
MacBeth (1973) regressions to control for various firm or in-
dustry characteristics. Another reason to consider this approach
is that it is based on firms/stocks rather than portfolios. Thus,
Fama-MacBeth regressions provide firm-level evidence for whether
patent infringement litigation explains stock returns. In each
month from July of year t to June of year t + 1, we regress monthly
returns of individual stocks on the indicator variable INF RINGERi,t
or the continuous variable LOGNCASEi,t , together with other con-
trol variables from year t – 1 (variable definitions are provided in
the Appendix). INF RINGERi,t is an indicator variable that equals
one for firms that are sued for patent infringement in the past 12
months (July of year t – 1 to June of year t). LOGNCASEi,t is the
log of one plus the number of patent infringement lawsuits filed
against the firm over the past 12 months. In the second stage,
6
Journal of Banking and Finance 148 (2023) 106740
we calculate the time-series averages and standard errors of co-
efficients for each explanatory variable and use the corresponding
t-statistics for statistical inferences. Our sample includes all firms
in the alleged infringer portfolio and the control portfolio from the
previous section.
In Table 3 we provide the means and t-statistics based on
the time series of the coefficients on all explanatory variables
from Fama-MacBeth regressions. We consider four models that in-
clude different combinations of explanatory variables. The first four
columns use INFRINGER and the last four columns use LOGNCASE.
The coefficients on INFRINGER are positive in all columns, with a
magnitude of 52–66 basis points per month and with t-statistics
ranging between 2.32 and 2.57. The coefficients on LOGNCASE are
also positive in all columns, with a magnitude of 66–90 basis
points per month (and with t-statistics of at least 2.52). Conse-
quently, our baseline findings that the stock returns of firms being
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

Table 3
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.
INFRINGER is an indicator variable equal to one for a firm in month t if the firm is sued for patent infringement over the past 12 months (t-11 to t) as either a plaintiff
or defendant, and zero otherwise. LOGNCASE is the log of one plus the number of patent infringement lawsuits against the firm filed over the past 12 months (t-11 to
t). We include INFRINGER in columns (1)-(4) and LOGNCASE in columns (5)-(8). In each month t from December 20 0 0 to December 2014, we conduct a cross-sectional
regression by regressing the monthly excess returns of all firms in month t + 1 on INFRINGER or LOGNCASE of all firms in month t, and control variables known in
month t. Such cross-sectional regressions lead to an estimate of the coefficient on INFRINGER and LOGNCASE in every month. We then test if the average of monthly
coefficients on INFRINGER and LOGNCASE are 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), and 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). 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.

(1) (2) (3) (4) (5) (6) (7) (8)

INFRINGER 0.0053 0.0052 0.0066 0.0054

(2.51) (2.57) (2.45) (2.32)
LOGNCASE 0.0066 0.0071 0.0090 0.0078
(2.68) (2.83) (2.57) (2.52)
RET −0.0221 −0.0244 −0.0305 −0.0225 −0.0255 −0.0308
(−1.89) (−2.06) (−2.47) (−1.91) (−2.12) (−2.48)
LOGBM −0.0005 −0.0005 0.0001 −0.0005 −0.0004 −0.0001
(−0.31) (−0.37) (0.03) (−0.28) (−0.27) (−0.06)
LOGME −0.0008 −0.0007 −0.0008 −0.0009 −0.0007 −0.0008
(−0.95) (−0.83) (−0.83) (−0.99) (−0.82) (−0.86)
MOM11 −0.0045 −0.0047 −0.0051 −0.0043 −0.0045 −0.0049
(−0.95) (−1.01) (−1.07) (−0.91) (−0.97) (−1.03)
MOM36 −0.0047 −0.0050 −0.0044 −0.0047 −0.0051 −0.0044
(−2.69) (−2.86) (−2.40) (−2.71) (−2.89) (−2.42)
LOGNPATENT 0.0311 0.0241 0.0341 0.0249
(0.89) (0.78) (0.93) (0.79)
LOGXRD −0.0021 0.0056 −0.0026 0.0038
(−0.18) (0.32) (−0.21) (0.23)
INV −0.0012 −0.0016
(−0.33) (−0.44)
OP 0.0064 0.0053
(1.43) (1.29)

N 162 162 162 162 162 162 162 162

Adjusted R2 −0.02% 5.86% 7.54% 8.39% −0.07% 5.85% 7.60% 8.42%

sued for patent infringement are significantly higher remain robust
when we control for relevant firm-specific variables. Therefore, the
significantly higher stock returns of alleged infringers do not ap-
pear to be attributed to firm characteristics.
3.3. Subsequent stock returns on portfolios of plaintiff and control
firms
We also examine plaintiffs’ subsequent stock returns using the
calendar-time portfolio approach: At the end of every month t,
from January 20 0 0 to November 2014, we use propensity score
matching (PSM) to find treated and control firms. Specifically, in
each month we compile the list of firms that sued other public
firms for patent infringement within the previous 12 months; each
plaintiff in each month is matched with another firm (i.e., control
firm) with the same SIC 2-digit industry code that has the closest
distance in size, book-to-market, momentum, and the number of
patents over the past ten years (using a caliper of 0.2). In Panel
B1 of Table 1, we report summary statistics for all variables in
our firm-year observations for plaintiffs. The mean (median) al-
leged infringer experiences 1.7 (1) lawsuits per year. In Panel B2
we present summary statistics for all variables in our firm-year ob-
servations for matched control firms.
We then form a portfolio of plaintiffs that have matched con-
trol firms (“the plaintiff portfolio” henceforth), and a portfolio of
control firms (“the control portfolio”). We then track the value-
weighted returns of these two portfolios in the next month. We
also construct a long-short portfolio by taking a long position in
the alleged infringer portfolio and a short position in the control
portfolio. We rebalance each portfolio at the end of each month,
and report the average returns and alphas on each portfolio in
Table 4.
In Model 1 of Table 4 we present the average monthly excess
returns (i.e., monthly returns in excess of the one-month T-bill
rate) of the plaintiff portfolio, the control portfolio, and the long-
short portfolio. The plaintiff portfolio’s average monthly excess re-
turn is 40 basis points per month, which is not significantly dif-
ferent from the control portfolio with an average monthly excess
return of 34 basis points. In addition, the long-short portfolio’s av-
erage return is 6 basis points per month with a t-statistic of 0.25.
We then consider various systematic risks and estimate the al-
phas of the long-short portfolio based on different factor models in
Models 2 to 8 in Table 4. All of these factor models have been ex-
plained in Section 3.1. The alphas of the long-short portfolio range
between 2 basis points and 19 basis points and are all insignificant.
Therefore, the plaintiff stocks do not differ from matched control
stocks in subsequent stock returns adjusted for various systematic
risk factors.
The insignificant returns on the plaintiff portfolio and the long-
short portfolio presented in Table 4 suggest that plaintiffs’ litiga-
tion information has been correctly embedded in their stock prices
and that their stock returns are not subject to new systematic risk
exposure.

7
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

4. Possible explanations

To explain the intriguing return predictability related to patent

infringement, we propose four possible explanations. First, in-
vestors could be excessively pessimistic about patent infringement
litigation and thus over-discount alleged infringers’ stock prices.

4) as in Chan et al. (2001) and Lev et al. (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 et al. (2005)
includes firms that have been plaintiff in litigation cases in the past 12 months, and control firms are matched in the same year by 2-digit SIC codes that have patents over the past ten years

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

Hou et al. (2015) q-factor model (Model 7); and the Daniel, Hirshleifer, and Subramanuam (1998) DHS model (Model 8). The definitions of these factors can be found in Section 3.1. The sample
and have the closest distance in size, book-to-market ratio, momentum, and the number of patents over the past ten years. In each month from January 20 0 0 to November 2014, we form the

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 et al. (2013); the
firms. We then hold these two portfolios and track the value-weighted returns on these portfolios as well as their differences 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
In this table, we provide the mean excess returns and t-statistics (Newey-West t-statistics are provided in parentheses) of portfolios based on patent litigation plaintiffs. The plaintiff portfolio

Plaintiff portfolio including all firms (for which we can find matched control firms) suing for patent infringement in the past 12 months. We also form the Control portfolio including all control

Underestimated stocks’ prices would subsequently reverse to their

(−0.04)
true values, leading to return predictability. Second, unknown sys-

−0.01%

(0.42)

(0.47)
0.09%

0.10%
DHS
tematic risk related to patent litigation might exist, and firms sued

(8)
for patent infringement would thus carry higher exposure to such
risk (thus providing higher expected stock returns). Third, while
high cash holdings (or favorable market prospects) make firms
q-theory
4-factor

(0.06)

(0.35)

(0.24)
more likely to be sued, they could also lead to higher future stock

0.01%

0.06%

0.05%
(7)

returns if these cash-rich firms are more likely to survive in the

long-run. Finally, firms sued for patent infringement might also be
subject to more financial constraints and would thus be riskier.
factor + Efficiency
Fama-French 4-

4.1. Underpriced alleged infringers

(−0.22)
−0.04%

(0.79)

(0.91)
0.15%

0.19%
(6)

Patent infringement litigation is generally regarded as bad

news for the defendant and associated with stock price declines
4-factor + Patent

(Bhagat et al., 1994; Lerner, 1995; Bessen and Meurer, 2012). In-
vestors tend to be overly pessimistic about this news, as the psy-
Fama-French

chology literature has offered abundant evidence for individuals’

“negativity bias”, i.e., people reacting more strongly to events re-
(0.02)

(0.99)

(0.86)
0.18%

0.18%
0.00%
(5)

lated to negative emotions (see Baumeister et al., 2001; Rozin and

Royzman, 2001). The finance literature has also provided sup-
portive evidence for such excessive pessimism among investors
4-factor + R&D

(Tetlock, 2007; Garcia, 2013). In addition, recent studies find that

Fama-French

investors underreact to news about firms’ patents because in-

(−0.06)
−0.01%

vestors have limited processing power for complex information in

(0.98)

(0.94)
0.18%

0.19%

patents and tend to underprice stocks with patent news due to

(4)

uncertainty aversion (Cohen et al., 2013; Hirshleifer et al., 2013;

2018). Since patent infringement litigation is even more complex,
factor + RMW + CMA

it is likely to result in pessimistic discounts in stock prices (and

thus higher subsequent stock returns).
Fama-French 4-

To examine the excessive pessimism explanation, we imple-

The returns of two portfolios consisting of plaintiffs and matched control firms.

ment the following two sets of tests. The first set of tests is re-
(−0.56)

(−0.47)
−0.11%

−0.09%

(0.10)
0.02%

lated to mispricing. We study if the litigation effect is stronger

(3)

among firms that are more subject to mispricing as proxied by id-

period for portfolio returns is from February 20 0 0 to December 2014.

iosyncratic volatility (Zhang, 2006), short-sale costs (Beneish et al.,

2015), stock return R2 (Hou et al., 2013), and zero-return days
(Lesmond et al., 1999). We provide the definitions of these prox-
Fama-French

ies in the Appendix. A stock’s mispricing degree increases with id-

4-factor

iosyncratic volatility and short-sale costs because greater idiosyn-

(0.22)

(1.17)

(0.84)
0.04%

0.22%

0.17%
(2)

cratic volatility and short-sale costs would be tied to higher short-

sale constraints, decreases with its R2 because a lower R2 with
market returns reflects higher information delays, and increases
with the number of zero-return days because more zero-return
days reflect higher arbitrage costs.
No factor

For each month from January 20 0 0 to November 2014, we clas-

(0.97)

(1.26)

(0.25)
0.34%

0.40%

0.06%

sify all firms into three groups based on each of the mispric-
(1)

ing proxies: The group consisting of firms with mispricing prox-

ies below the 30th percentile is defined as the “low mispricing”
Plaintiff - Control
Plaintiff portfolio
Control portfolio

group, the group consisting of firms with mispricing proxies above

the 70th percentile is defined as the “high mispricing” group, and
return/alphas

the group consisting of firms with mispricing proxies between the

30th and 70th percentiles is defined as the “middle mispricing”
Excess

t-stat

t-stat

t-stat
Table 4

group. We then construct portfolios of alleged infringers as defined

in Table 2 in each group and track their value-weighted excess re-
turns for the next month. We present the difference in excess re-
turns (High-Low), defined as the difference in excess returns be-
tween the high and low mispricing portfolios in Table 5. This dif-
ference reflects how much alleged infringers’ stock returns are re-
lated to mispricing.

8
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

Table 5
Portfolio analysis conditional on mispricing.
In this table, we provide the mean excess returns and t-statistics of various portfolios conditional on mispricing. We consider four proxies: (i) Idiosyncratic volatility
in Panel A; (ii) short-sale costs in Panel B, (iii) stock return R-squared in Panel C, and (iv) zero return days from Lesmond et al. (1999) in Panel D. We measure
idiosyncratic volatility with the standard deviation of the residual values from the Fama-French three-factor model using monthly data over the past 12 months.
Short-sale costs are proxied with the monthly average of Daily Cost of Borrowing Score (DCBS) from Markit. DCBS measures the relative cost of borrowing for each
stock, ranging from 1 (low cost, easiest to borrow) to 10 (highest cost, most difficult to borrow). Following Hou et al. (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 of 24 observations to estimate R2 . Following Lesmond et al., 1999, zero-return days is defined as the proportion of a
firm’s daily returns over the past six months that are equal to zero. With stock return R2 , low values reflect high mispricing; with the three other measures high
values reflect high mispricing. In each month from January 20 0 0 to November 2014, we form three portfolios based on these four proxies: The Low group includes
firms with the proxy below the 30th percentile of mispricing (i.e., the lowest mispricing group), the Middle group includes firms with the proxy between the 30th and
70th percentiles of mispricing, and the High group includes firms above the 70th percentile of mispricing (i.e., the highest mispricing group). We then track the value-
weighted return on alleged infringer firms as defined in Table 2 of 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 et al. (2001) and Lev et al. (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 et al. (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 et al. (2013); the Hou et al. (2015) q-factor model (Model 7); and the Daniel, Hirshleifer, and Subramanuam (1998) DHS model (Model
8). The definitions of these factors can be found in Section 3.1. The sample period for portfolio returns is from February 20 0 0 to December 2014, except for DCBS
portfolios start from 2004 due to data availability. Newey-West adjusted t-statistics are provided in parentheses.
Panel A: Conditional on idiosyncratic volatility
(1) (2) (3) (4) (5) (6) (7) (8)
Fama-French
Fama-French Fama-French 4-factor Fama-French 4-factor Fama-French 4-factor 4-factor + q-theory
Excess return/alphas No factor 4-factor + RMW + CMA + R&D + Patent Efficiency 4-factor DHS
Low mispricing 0.72% 0.54% 0.42% 0.53% 0.52% 0.44% 0.53% 0.48%
(1.80) (2.08) (1.60) (1.89) (1.99) (1.79) (1.65) (1.68)
Middle mispricing 0.63% 0.45% 0.22% 0.39% 0.41% 0.44% 0.49% 0.49%
(1.03) (1.55) (0.85) (1.36) (1.48) (1.48) (1.53) (2.03)
High mispricing 2.20% 1.67% 2.61% 1.57% 1.65% 1.84% 2.07% 2.24%
(2.10) (2.40) (3.71) (2.14) (2.31) (2.52) (3.24) (3.55)
High-Low 1.47% 1.14% 2.19% 1.04% 1.12% 1.41% 1.54% 1.76%
t-stat (1.78) (1.67) (3.28) (1.42) (1.62) (1.97) (2.44) (2.94)
Panel B: Conditional on short-sale costs
(1) (2) (3) (4) (5) (6) (7) (8)
Excess return/alphas No factor Fama-French Fama-French Fama-French Fama-French Fama-French q-theory DHS
4-factor 4-factor+RMW+CMA 4-factor+R&D 4-factor+Patent 4-factor + 4-factor
Efficiency
Low mispricing −0.66% −0.53% −0.43% −0.54% −0.61% −0.88% −0.49% −0.41%
(−0.87) (−1.50) (−0.72) (−1.50) (−1.80) (−1.90) (−1.90) (−1.70)
Middle mispricing 0.22% 0.76% 0.86% 0.75% 0.79% 0.88% 0.49% 0.81%
(0.52) (3.36) (2.44) (3.27) (3.24) (3.12) (1.83) (3.48)
High mispricing 1.34% 1.08% 1.81% 1.47% 0.98% 0.66% 1.27% 1.58%
(1.38) (1.37) (4.00) (2.66) (1.08) (0.65) (1.59) (3.11)
High-Low 2.00% 1.62% 2.23% 2.01% 1.59% 1.53% 1.76% 2.00%
t-stat (3.27) (2.30) (2.56) (4.21) (1.96) (1.74) (2.26) (3.22)
Panel C: Conditional on stock return R-squared
(1) (2) (3) (4) (5) (6) (7) (8)
Excess return/alphas No factor Fama-French Fama-French 4-factor Fama-French 4-factor Fama-French 4-factor Fama-French q-theory DHS
4-factor + RMW + CMA + R&D + Patent 4-factor + Ef- 4-factor
ficiency

Low mispricing 0.80% 0.49% 0.35% 0.46% 0.47% 0.44% 0.43% 0.40%
(2.11) (2.90) (2.11) (2.86) (2.89) (2.62) (2.33) (2.35)
Middle mispricing 0.68% 0.25% 0.26% 0.29% 0.28% 0.31% 0.14% 0.30%
(1.50) (0.70) (0.75) (0.84) (0.81) (0.90) (0.40) (0.85)
High mispricing 2.47% 1.87% 1.66% 1.92% 1.95% 2.01% 1.38% 1.60%
(3.07) (2.67) (2.70) (2.90) (2.78) (3.06) (2.16) (2.53)
High-Low 1.67% 1.37% 1.31% 1.46% 1.48% 1.57% 0.95% 1.21%
t-stat (2.05) (1.92) (2.01) (2.14) (2.08) (2.34) (1.46) (1.87)
Panel D: Conditional on zero return days
(1) (2) (3) (4) (5) (6) (7) (8)
Excess return/alphas No factor Fama-French Fama-French 4- Fama-French Fama-French Fama-French q-theory DHS
4-factor factor + RMW + CMA 4-factor + R&D 4-factor + Patent 4-factor + Ef- 4-factor
ficiency

Low mispricing 0.69% 0.50% 0.31% 0.45% 0.47% 0.44% 0.41% 0.40%
(1.68) (2.11) (1.28) (2.02) (1.99) (1.83) (1.65) (1.75)
Middle mispricing 0.94% 0.68% 0.54% 0.60% 0.62% 0.61% 0.71% 0.69%
(2.01) (1.99) (1.63) (1.76) (1.82) (1.75) (1.76) (1.72)
High mispricing 2.86% 2.28% 2.64% 2.35% 2.42% 2.55% 2.75% 3.20%
(2.56) (2.20) (2.50) (2.47) (2.30) (2.46) (2.39) (2.70)
High-Low 2.16% 1.79% 2.33% 1.90% 1.95% 2.12% 2.34% 2.79%
t-stat (2.12) (1.78) (2.22) (2.01) (1.93) (2.15) (2.08) (2.32)

9
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

In all panels of Table 5, we find that the alleged infringers’ stock

returns are higher among firms that are more subject to mispricing

factor based on R&D expense divided by ME (Model 4) as in Chan et al. (2001) and Lev et al. (2005); the Fama-French four factor plus a patent factor based on the number of patents divided by total assets (Model
is the ratio of the absolute value of CAR to the absolute value of the analyst forecast error. In each month from January 20 0 0 to November 2014, we form three portfolios based on these four proxies: The Low group

5) as in Hall et al. (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 et al. (2013); the
percentile. We then track the value-weighted return on alleged infringer firms as defined in Table 2 of these portfolios for the next month. We also form the High-Low portfolio by taking a long position in the High

Hou et al. (2015) q-factor model (Model 7); and the Daniel, Hirshleifer, and Subramanuam (1998) DHS model (Model 8). The definitions of these factors can be found in Section 3.1. The sample period for portfolio
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
includes firms with the proxy below the 30th percentile, the Middle group includes firms with the proxy between the 30th and 70th percentiles, and the High group includes firms with the proxy above the 70th
In this table, we provide the mean excess returns and t-statistics of various portfolios conditional on investor pessimism. To capture the degree of pessimism, we restrict our sample to firms with negative three-day

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,
CAR in excess of the market return and negative analyst forecast error (difference between the actual earnings and consensus forecast divided by stock prices) from earnings announcements. Our pessimism measure
(i.e., higher idiosyncratic volatility, higher short-sale costs, lower
return R2 , and more zero-return days). In Panel A, the excess re-
turns/alphas of alleged infringers with high idiosyncratic volatility
are significantly positive, and are higher than those with low id-
iosyncratic volatility as the differences in excess returns/alphas in

(−1.80)

(−2.51)
−1.06%

−1.35%

(1.02)

(1.90)
1.57%
0.51%
the High-Low row range from 104 to 219 basis points per month

DHS
(8)
and are (marginally) significant in many models. In Panel B, the
differences in excess returns/alphas between the high and low
groups range from 153 to 223 basis points per month and are sta-
tistically significant in all but one model.
In Panel C, the excess returns/alphas of alleged infringers with

q-theory
low return R2 are significantly positive and are higher than those

4-factor

(−2.32)

(−3.13)
−1.26%

−1.32%

(1.34)

(2.37)
1.94%
0.68%
with high return R2 , as shown by the significantly positive dif-

(7)
ferences in the High-Low row. The differences range from 95 to
167 basis points per month (depending on the model used) and

factor + Efficiency
are statistically significant in all but one model. In Panel D, the

Fama-French 4-
excess returns/alphas of alleged infringers with more zero-return
days are significantly positive. In addition, the differences in ex-

(−2.60)

(−3.45)
−1.31%

−1.45%
cess returns/alphas between the high and low groups range from

(1.37)

(2.61)
0.73%

2.04%
179 to 279 basis points per month and are statistically significant

(6)
in almost all models.
In the second set of tests, we construct a measure to approx-

4-factor + Patent
imate investors’ pessimism of a stock. To capture pessimism, we
focus on firms with negative CAR and negative analyst forecast er-

Fama-French
rors from earnings announcements. CAR is the three-day cumula-

(−2.80)

(−3.24)
−1.36%

−1.44%
tive announcement return in excess of the market return. Analyst

(1.53)

(2.88)
2.19%
0.83%
forecast error is the difference between the actual earnings and

(5)
consensus forecast divided by stock prices. To capture the degree
of pessimism, we calculate the ratio of the absolute value of CAR
to the absolute value of analyst forecast error. This measure, there-

factor + RMW + CMA 4-factor + R&D

returns is from February 20 0 0 to December 2014. Newey-West adjusted t-statistics are provided in parentheses.
fore, reflects the sensitivity of investors’ reaction to bad news on a

Fama-French
stock.

(−2.63)

(−3.32)
−1.37%

−1.45%

(1.51)

(2.68)
Similar to Table 5, we classify all firms into three groups based

2.19%
0.82%
(4)
on the pessimism measure. Table 6 reports the mean excess re-
turns and alphas for the three groups and the high minus low
portfolio (High-Low). The returns and alphas of the High-Low port-
folio reflect how much the alleged infringers’ stock returns are re-
Fama-French 4-

lated to investors’ pessimism. We find that the differences between

the high and low groups ranging from 157 basis points to 219 basis (−2.62)

(−3.45)
−1.52%

−1.42%

(0.58)

(2.30)
1.84%
0.31%
points, which are statistically significant at the 5% level or greater
(3)

in all but two models.

Tables 5 and 6 collectively provide strong support for a
pessimism-driven mispricing explanation of our results. Due to
over-pessimism that is amplified by all kinds of behavioral issues
Fama-French

such as uncertainty aversion and limited information processing

ability, investors underprice alleged infringers, resulting in return
4-factor

(−2.46)

(−3.34)
−1.26%

−1.32%

(1.69)

(2.63)
2.13%
0.88%

predictability.
(2)

4.2. Unknown systematic risk related to patent litigation

Portfolio analysis conditional on pessimism.

To examine the unknown systematic risk explanation, we con-

sider three asset pricing tests. First, we implement a two-pass pro-
No factor

cedure to test if the return on the long-short portfolio (i.e., a port-

(−0.61)

(−1.04)
−0.58%

−0.83%

(1.86)

(1.88)
1.02%

1.59%

folio that takes a long position in the alleged infringer portfolio

(1)

and a short position in the control portfolio) serves as a risk factor

and is priced in the cross-section of stock returns. Second, we con-
struct portfolios based on individual stocks’ exposure to an aggre-
gate patent litigation shock based on a rolling window, and exam-
return/alphas

ine if a mimicking portfolio’s returns explain the time-series vari-

High-Low
Middle

ation of our litigation portfolio returns. Third, we estimate a linear

Excess

t-stat
Table 6

High
Low

stochastic discount factor (SDF) that includes the aggregate patent

litigation shock, and examine if that shock loads in the SDF in ex-
plaining a group of test assets that reflect the cross-section of stock
returns related to patent infringement litigation.

10
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

Table 7
Tests for unknown systematic risk related to patent litigation.
This table presents three asset pricing tests for an unknown risk factor related to patent infringement litigation. In Panel A, we implement a two-pass procedure
(see Cochrane (2001)). We use the returns of the long-short portfolio from Table 2 as the litigation risk factor. First, we conduct a rolling window estimation
to estimate the beta associated with the litigation risk, β i,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 β i,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 (β MKT ), size factor (β SMB ),
and value factor (β HML ). 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 the 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 A1 presents results with 60-month estimates of beta, and Panel A2 presents results with
12-month estimates of beta. T-statistics based on Newey-West adjusted standard errors are provided in parentheses. In Panel B, we construct a portfolio based
on individual stocks’ exposure to an aggregate patent litigation shock based on a rolling window. In each month from January 2004 to November 2014, we
define an aggregate litigation shock as the growth rate of the number of all patent lawsuits reported in a year relative to its average from the past three years.
We then regress each stock’s returns on either Fama and French (1992) three factors and this shock (column (1)) or this shock only (column (2)) to calculate its
“beta to litigation shock” using rolling windows over the past five years. We then construct a mimicking factor for litigation shock based on the Fama-French
method that sorts all firms by the betas to the litigation shock and market size. The definitions of these factors can be found in Section 3.1. The sample period
for portfolio returns is from February 2004 to December 2014. Newey-West adjusted t-statistics are provided in parentheses. In Panel C, we estimate a linear
stochastic discount factor (SDF) that includes the aggregate patent litigation shock to test whether the shock loads in the SDF in explaining a group of test
assets that reflect the cross-sectional variation of stock returns related to patent litigation. Our test assets include the treated portfolio, the control portfolio,
and their spread from Table 2. We report the estimate and statistical significance of the loading and implied price of risk based on Kan et al. (2013). The
time-series average of the number of observations (N) and the adjusted R2 are also reported in the bottom in panels A and B.
Panel A1: Two-pass procedure based on 60-month estimate of beta
Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Intercept 0.009 0.009 0.010
(2.15) (2.25) (1.80)
β Mkt 0.001 0.001 0.006 0.006
(0.55) (0.60) (1.62) (1.72)
β Litigation 0.0 0 0 0.0 0 0 0.0 0 0 0.0 0 0 0.0 0 0 −0.004
(0.16) (0.29) (−0.06) (0.63) (0.55) (−1.60)
β SMB −0.001 0.001
(−0.51) (0.70)
β HML 0.002 0.002
(1.54) (2.01)

N 3059 3059 3059 3059 3059 3059

Adjusted R2 1.47% 1.80% 0.26% 9.62% 10.15% 2.59%

Panel A2: Two-pass procedure based on 12-month estimate of beta

Model 1 Model 2 Model 3 Model 4 Model 5 Model 6
Intercept 0.008 0.008 0.009
(1.99) (2.04) (1.58)
β Mkt 0.001 0.001 0.005 0.005
(0.44) (0.50) (1.44) (1.52)
β Litigation 0.001 0.001 0.001 0.001 0.001 −0.002
(0.96) (1.40) (0.67) (1.27) (1.52) (−0.88)
β SMB −0.001 0.001
(−0.77) (0.49)
β HML 0.002 0.002
(1.57) (1.40)

N 3448 3448 3448 3448 3448 3448

Adjusted R2 1.66% 1.97% 0.26% 9.58% 10.03% 2.12%

Panel B: Portfolio based on betas to patent litigation shock

Model (1) (2)
Excess return/alphas 0.49% 0.48%
(3.20) (3.04)
MKT −9.49% −7.62%
(−2.34) (−1.68)
SMB 1.78% 3.32%
(0.24) (0.41)
HML −14.21% −15.50%
(−1.60) (−1.71)
UMD −5.23% −5.82%
(−1.45) (−1.51)
Portfolio on betas to 0.24% −6.81%
patent litigation
shock
(0.02) (−0.70)
N 131 131
Adjusted R2 4.37% 4.89%
(continued on next page)

11
F. Bereskin, P.-H. Hsu, W. Latham et al.
Table 7
(continued)
Panel C: GMM test for the existence of aggregate patent litigation shock in the SDF
Model 1 Patent litigation shock
Risk Premium (b) 2.787
[Shanken t-statistics] [1.04]
{GMM t-statistics} {0.90}
Price of Covariance Risk (λ) 0.146
[Shanken t-statistics] [1.05]
{GMM t-statistics} {0.89}
Model 2 Patent litigation shock
Risk Premium (b) −89.996
[Shanken t-statistics] [−0.08]
{GMM t-statistics} {−0.09}
Price of Covariance Risk (λ) −4.593
[Shanken t-statistics] [−0.08]
{GMM t-statistics} {−0.09}
First, we employ a two-pass procedure by treating the long-
short portfolio we construct in Section 3.1 as a mimicking portfolio
with returns reflecting the risk compensation for bearing one unit
of risk exposure to a systematic risk associated with being sued
for patent infringement (see Fama and French (1993)). We refer
to the monthly returns on the long-short portfolio as the “litiga-
tion factor.” Then, we test if this factor is priced across all stocks
by implementing a two-pass procedure (see Cochrane (2001)). The
results across all specifications in Panels A1 and A2 of Table 7 in-
dicate that the coefficient (i.e., lambda) on β Litigation is consistently
insignificant. In Panel A1 (Panel A2) we present our results using
60 months (12 months) to estimate beta. The insignificant coeffi-
cients on β Litigation that reflects litigation risk premium cast doubt
on the likelihood that our results are driven by any unknown sys-
tematic risk associated with patent litigation.
Second, we construct a portfolio based on individual stocks’ ex-
posure to aggregate patent litigation shocks based on a rolling win-
dow, and then examine whether this portfolio’s returns explain the
time-series variation of the long-short portfolio’s returns. We use
the growth rate of the number of all patent lawsuits in a year rel-
ative to the average number over the past three years as our proxy
for the aggregate patent litigation shock. In each month from Jan-
uary 2004 to November 2014, we regress each stock’s returns on
either Fama and French (1992) three factors and this shock (col-
umn (1)) or this shock only (column (2)) to calculate its “beta to
the litigation shock” using rolling windows over the past five years.
We then construct a mimicking factor for the litigation shock based
on the Fama-French method that sorts all firms by the betas to the
litigation shock and market size. We regress the long-short portfo-
lio’s excess return on this mimicking factor, as well as other risk
factors. The coefficient estimates and their statistical significance
for all linear factors are provided in Panel B of Table 7. The coef-
ficient on the mimicking factor appears insignificant, inconsistent
with an unknown systematic risk explanation.
Finally, we implement the GMM test of Kan et al. (2013) to es-
timate if the patent litigation shock exists in a linear SDF in ex-
plaining a group of test assets that reflect the cross-sectional vari-
ation of stock returns related to patent litigation. Our test assets
include the alleged infringer portfolio, the control portfolio, and
the long-short portfolio from Table 2. Panel C of Table 7 reports
the estimate and statistical significance of the existence of the ag-
gregate patent litigation shocks in the SDF (and implied price of
risk) as in Kan et al. (2013). The loading and implied price of risk
are insignificant, which does not support an unknown systematic
risk associated with the patent litigation shock.
Consequently, all three asset pricing tests suggest that the re-
turn predictability associated with patent infringement cannot be
attributed to unknown systematic risk.
Journal of Banking and Finance 148 (2023) 106740
p-value of testing R-square=0
imposing H0: λ =0 0.272
Not imposing H0: λ =0 0.381
Market Factor p-value of testing R-square=0
86.302 imposing H0: λ =0 0.234
[0.09] Not imposing H0: λ =0 0.966
{0.10}
0.036
[0.11]
{0.12}
4.3. Cash holdings
In Table 8, we consider an important driver of litigation—
cash—that may explain our baseline finding. Firms with larger
cash balances are known to attract patent infringement litigation
since these firms are able and/or more willing to settle lawsuits
(Cohen et al., 2019; Lee et al., 2021). This would especially be the
case for NPEs; although this is less likely to be the case for liti-
gation among practicing entities, we still evaluate this alternative
explanation for robustness. Cash-rich firms are also more likely
to survive patent litigation or other economic downturns. Con-
sequently, it is conceivable that our finding of excess returns is
driven by cash-rich firms in the event that those firms both (a) at-
tract more patent litigation and (b) experience future stock return
outperformance.
To evaluate this explanation, we implement one-way sorts
based on our proxy for cash holdings, which is defined as cash and
marketable securities scaled by lagged total assets. In each month,
we divide all firms into three groups, based on their cash holdings.
These three groups are defined by the 30th and 70th percentiles
of cash holdings: The low group includes firms with cash holdings
below the 30th percentile, the high group includes firms above the
70th percentile, and the middle group includes firms between the
30th and 70th percentiles. We then construct portfolios of alleged
infringers in each group and track their value-weighted excess re-
turns in each month. At the bottom of each panel, we report the
mean excess return and alphas (and corresponding t-statistics) of a
high-minus-low (High-Low) portfolio that takes a long position in
the high portfolio and a short position in the low portfolio. If al-
leged infringers’ higher stock returns are caused by cash, we would
expect a stronger predictive ability in the high portfolio (i.e., the
mean excess return and alphas of the high portfolio are higher
than those of the low portfolio).
In Panel A of Table 8, the positive returns are not significantly
larger among cash-rich firms, which indicates that the return pre-
dictability is not driven by cash-rich firms being more likely to at-
tract patent litigation or to survive patent lawsuits.
4.4. Financial constraints
Another potential risk-based explanation for our results is that
costly patent litigation particularly affects financially constrained
firms, as R&D-intensive firms incur greater systematic risk when
they are under financial constraints (Li, 2011). Costly patent lit-
igation makes these R&D-intensive firms subject to such risk
(Lanjouw and Schankerman, 2004; Appel et al., 2019; Lee, Oh, and
Suh, 2019), and this explanation would predict excess returns to be
concentrated in those financially constrained firms.
12
 F. Bereskin, P.-H. Hsu, W. Latham et al.
Table 8
Portfolio analysis conditional on cash holdings and financial constraints.
In this table, the sorting is based on cash and marketable securities scaled by lagged total assets (Panel A), and the Kaplan-Zingales index (Panel B). We provide the mean excess returns and t-statistics (Newey-West t-statistics
are provided in parentheses) of various portfolios, conditional on cash. In each month from January 20 0 0 to November 2014, we form three portfolios by either cash balance or financial constraints: The Low group includes firms
below the 30th percentile, the Middle group includes firms between the 30th and 70th percentiles, and the High group includes firms above the 70th percentile. We then track the value-weighted return on alleged infringer
firms as defined in Table 2 of 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 et al. (2001) and Lev et al. (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 et al. (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 et al. (2013); the Hou et al. (2015) q-factor model (Model 7); and the Daniel, Hirshleifer, and Subramanuam (1998) DHS model (Model 8). The
definitions of these factors can be found in Section 3.1. The sample period for portfolio returns is from February 20 0 0 to December 2014.

Panel A: Conditional on cash balance

(1) (2) (3) (4) (5) (6) (7) (8)
Excess Fama-French Fama-French 4- Fama-French Fama-French Fama-French 4- q-theory
return/alpha No factor 4-factor factor + RMW + CMA 4-factor + R&D 4-factor + Patent factor + Efficiency 4-factor DHS
13

Low 0.96% 0.53% 0.20% 0.51% 0.51% 0.54% 0.48% 0.53%

Middle 0.61% 0.32% 0.11% 0.28% 0.29% 0.25% 0.12% 0.17%
High 0.84% 0.78% 0.77% 0.68% 0.71% 0.66% 0.99% 0.84%
High-Low −0.12% 0.25% 0.57% 0.17% 0.21% 0.12% 0.50% 0.31%
t-stat (−0.20) (0.52) (1.23) (0.37) (0.47) (0.25) (0.98) (0.67)

Panel B: Conditional on financial constraints

(1) (2) (3) (4) (5) (6) (7) (8)
Excess Fama-French Fama-French 4- Fama-French Fama-French Fama-French 4- q-theory
return/alpha No factor 4-factor factor + RMW + CMA 4-factor + R&D 4-factor + Patent factor + Efficiency 4-factor DHS

Low 0.64% 0.51% 0.34% 0.47% 0.48% 0.44% 0.40% 0.32%

Middle 0.77% 0.44% 0.62% 0.42% 0.43% 0.52% 0.54% 0.65%
High 0.95% 0.55% 0.39% 0.46% 0.48% 0.49% 0.70% 0.84%

Journal of Banking and Finance 148 (2023) 106740

High-Low 0.31% 0.05% 0.05% −0.01% −0.01% 0.05% 0.30% 0.52%
t-stat (0.58) (0.09) (0.10) (−0.02) (−0.01) (0.10) (0.52) (0.93)
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

Table 9
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 (models (1) and (2) and HHI (models (3) and (4); both are defined as in Hoberg and
Phillips (2016). All variables are regressed against the following additional explanatory variables from 20 0 0 to 2014:
A dummy variable equal to 1 if the firm is sued for patent infringement over the past 12 months (INFRINGER), the
growth rate of the book value of total assets (INV), the log of the book-to-market ratio (LOGBM), the log of the mar-
ket 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 ob-
servations (N) and the adjusted R2 are reported. All variables (except for INFRINGER) 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

INFRINGER −0.461 −0.472 0.012 0.011

(−2.77) (−3.32) (2.20) (2.42)
INV 1.680 1.635 −0.034 −0.035
(6.00) (6.07) (−9.00) (−8.16)
LOGBM 0.062 0.071 −0.024 −0.025
(1.12) (1.33) (−9.64) (−9.62)
LOGME 0.277 0.280 −0.033 −0.033
(18.53) (18.53) (−33.70) (−33.31)
LOGNPATENT −2.623 −2.492 0.033 0.022
(−2.20) (−2.09) (2.31) (1.97)
LOGXRD 12.380 12.162 −0.320 −0.321
(10.78) (11.05) (−17.82) (−17.03)
ROA −1.289 −1.266 0.003 0.002
(−6.74) (−6.39) (0.80) (0.56)

Industry fixed Yes Yes Yes Yes

effects
N 2719 2715 2719 2715
Adjusted R2 51.06% 50.52% 22.13% 21.02%

Table 10
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 20 0 0 to 2014 against the following explanatory variables: A dummy variable equal
to 1 if the firm is sued for patent infringement over the past 12 months (INFRINGER), 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 (ROE). 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 INFRINGER) are
winsorized at the 1% and 99% levels. Newey-West adjusted t-statistics are provided in parentheses.

(1) (2)
Average 5-year ROE Average 3-year ROE

INFRINGER 0.019 0.015

(3.38) (3.15)
INV −0.084 −0.074
(−8.14) (−9.08)
LOGBM −0.011 −0.012
(−1.29) (−1.58)
LOGME 0.018 0.016
(15.01) (13.23)
LOGNPATENT −0.010 −0.009
(−0.21) (−0.17)
LOGXRD −0.450 −0.428
(−21.06) (−18.36)
ROE 0.718 0.726
(17.05) (19.42)
ROE −0.078 −0.072
(−6.28) (−4.98)

Industry fixed-effects Yes Yes

N 2978 2977
Adjusted R2 55.94% 59.57%

14
F. Bereskin, P.-H. Hsu, W. Latham et al.
In Panel B of Table 8, we examine this possibility by cre-
ating portfolios sorted by financial constraints, based on the
Kaplan-Zingales index (1997) that measures firm-level financial
constraints. In particular, we classify all firms into three groups:
The low group includes firms with financial constraints below the
30th percentile, the high group includes firms with financial con-
straints above the 70th percentile, and the middle group includes
firms with financial constraints between the 30th percentile and
the 70th percentile. We then construct portfolios of alleged in-
fringers in each group and track their value-weighted excess re-
turns in each month. 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 takes a long posi-
tion in the high portfolio and a short position in the low portfo-
lio. If alleged infringers’ higher stock returns are caused by finan-
cial constraints due to patent infringement litigation, we would ex-
pect the mean excess return and alphas of the high portfolio to be
higher than those of the low portfolio.
Panel B of Table 8 shows that the mean excess return and al-
phas of the High-Low portfolio are statistically insignificant across
all models. This finding indicates that the return predictability as-
sociated with patent infringement does not concentrate on finan-
cially constrained firms. Thus, it is difficult to attribute our results
to the systematic risk associated with financial constraints.
5. Additional analyses: subsequent competition and profits of
alleged infringers
It is worth noting that the excessive pessimism explanation
provided and supported in Section 4.1 could be exacerbated by the
existence of potential benefits associated with patent infringement
litigation. The literature has pointed out that investors tend to
be over-pessimistic about innovation-related news and thus over-
discount the future values associated with firms’ innovation activi-
ties (Lev and Sougiannis, 1996; Chan et al., 2001; Hirshleifer et al.,
2013; 2018). Thus, if being sued for patent infringement brings any
benefits to the alleged infringers, those benefits would be under-
valued by pessimistic investors in the short run and thus lead to
return predictability in the long run.
In this section, we examine the existence of such potential ben-
efits, which would further support the existence of pessimism-
driven mispricing. Being sued for patent infringement might
be beneficial to alleged infringers for the following reasons.
First, patent litigation highlights the substantial barriers to en-
try associated with alleged infringers’ operations and products,
likely deterring potential competitors—especially smaller firms
with less extensive patent portfolios (Choi, 1998; Shapiro, 20 0 0;
Hall and Ziedonis, 2001; Bessen and Meurer, 2013; Chien, 2013;
Cohen et al., 2019). Second, a lawsuit highlights the profits earned
(or potentially being earned) from the alleged infringers’ use of
certain intellectual property. Alleged infringers would generally not
be sued if they were not generating (or not expected to generate)
substantial profits from the alleged patent infringement. Thus, the
occurrence of patent litigation suggests the (expected) substantial
profits of the alleged infringers to investors.8
We first examine if being sued for patent infringement high-
lights the barriers to entry and deters potential competitors. In par-
ticular, we examine the relation between being sued for patent in-
8
The litigation process would help clarify a firm’s intellectual property rights, al-
beit 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. Their findings imply that the uncer-
tainty of patent validity is economically important. In our setting focused on defen-
dants, we contend that the resolution of uncertainty regarding intellectual property
rights would ultimately provide clarity into whether or not the firm is violating a
patent (see, for example, Kiebzak, Rafert, and Tucker (2016)).
15
Journal of Banking and Finance 148 (2023) 106740
fringement and future market competition. We use five-year and
three-year averages of Similarity and HHI as defined in Hoberg and
Phillips (2016) based on textual analysis from firms’ 10-K annual
filings of their business descriptions to measure firms’ intensity
of product competition: Similarity is defined as a score describ-
ing how close the product descriptions of a firm’s competitors are
toward the firm’s product descriptions, and HHI is defined as the
Herfindahl-Hirschman Index based on sales of firms in the same
industry defined by their product descriptions. We perform an-
nual Fama-MacBeth cross-sectional regressions by regressing av-
erage Similarity and HHI over the subsequent three-year and five-
year periods on INFRINGER (the indicator variable for a firm be-
ing sued for patent infringement within the prior 12 months) and
other explanatory variables. Our sample includes all public firms
(except financial and utility firms) in the CRSP/Compustat database.
The results presented in Table 9 support the effects of increased
barriers to entry following patent litigation. Firms’ products be-
come more differentiated as Similarity in the following five years
(three years) declines by 0.46 (0.47) around this time. Industries
also become less competitive as defined with the sales-based HHI,
with average future HHI increasing by 1.2% (1.1%) in the subsequent
five- (three-) year periods. Consequently, using a range of industry-
level proxies for competition, we present evidence that patent liti-
gation discourages potential competitors.
Table 10 examines firms’ subsequent three-year and five-year
average ROE by performing annual Fama-MacBeth regressions
against INFRINGER and other explanatory variables. Our sample in-
cludes all public firms (except financial and utility firms) in the
CRSP/Compustat database. The coefficients on INFRINGER are sig-
nificantly positive in both specifications: Firms sued for patent in-
fringement are associated with an increase in the mean five-year
ROE of 1.9% and an increase in the mean three-year ROE of 1.5%.
These results support our argument that only profitable opportu-
nities will lead to patent infringement litigation.
6. Conclusion
Patent infringement litigation has important and wide-ranging
effects on firms, and firms are experiencing these types of chal-
lenges with increased frequency. Our empirical results suggest that
alleged infringers provide significantly positive stock returns in the
twelve months following infringement litigation. Our finding of al-
leged infringers’ return predictability is unique and calls for in-
depth investigation.
We examine the following four possible explanations. First, due
to negativity bias, investors tend to be overly pessimistic about
patent infringement litigation news and overly discount stock
prices, leading to subsequent return predictability. Second, firms
sued for patent infringement may carry higher exposure to un-
known systematic risk related to patent litigation and thus pro-
vide higher expected stock returns. Third, cash-rich firms are more
likely to be sued for patent infringement and might also be more
likely to survive the associated litigation. Finally, firms sued for
patent infringement may be subject to financial constraints and
could also carry higher systematic risk. Our empirical evidence
is supportive of the pessimism-driven mispricing explanation and
highlights the role of patent litigation in the asset pricing litera-
ture.
Declaration of Competing Interest
None.
Data Availability
Data will be made available on request.
F. Bereskin, P.-H. Hsu, W. Latham et al. Journal of Banking and Finance 148 (2023) 106740

Appendix. Variable definitions

Variable Definition

Patent litigation
INFRINGER A dummy variable equal to one if the firm is sued for patent infringement over the past 12 months, and zero
otherwise.
LOGNCASE The log of one plus the number of lawsuits filed against the firm for patent infringement over the prior 12 months.
Innovation factors
R&D 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 et al. (2001) and Lev et al. (2005). 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 et al. (2001).
PATENT FACTOR 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%). We scale the
number of granted patents by total assets following Hall et al. (2005) and Noel and Schankerman (2013).
INNOVATIVE EFFICIENCY The innovative efficiency factor is the difference between the monthly returns of the high efficiency portfolio and
FACTOR 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%). The construction of the innovative efficiency factor is motivated by Cohen et al. (2013) and
Hirshleifer et al. (2013).
Firm Characteristics
CF Cash-flow scaled by total assets.
HHI Herfindahl-Hirschman Index, as in Hoberg and Phillips (2016).
IDIOSYNCRATIC Standard deviation of the residual values from the Fama-French three-factor model using monthly data over the
VOLATILITY past 12 months.
INV Growth rate of the book value of assets.
KZ Kaplan-Zingales index.
LOGBM Log of the book-to-market ratio.
LOGME Log of the market value of equity.
LOGNPATENT Log of one plus the number of patents granted in the past 5 years divided by the book value of total assets.
LOGXRD Log of one plus the R&D expense over the past 5 years using a discount rate of 0.2, divided by total assets.
MOM11 Cumulative returns over the past twelve months, with a one-month gap.
MOM36 Cumulative returns over the past three years, with a one-year gap.
OP 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.
PESSIMISM The ratio of the absolute value of three-day cumulative abnormal return (CAR) in excess of market return and
analyst forecast error scaled by stock price. Sample is conditional on negative CAR and negative analyst forecast
error.
RET Stock returns over the previous month.
ROA Operating income before depreciation scaled by the lagged book value of assets.
ROE Operating income before depreciation scaled by the lagged book value of equity.
ROE The one-year change in ROE.
SHORT SALE COSTS Monthly average of Daily Cost of Borrowing Score (DCBS) from Markit. DCBS measures the relative cost of
borrowing for each stock, ranging from 1 (low cost, easiest to borrow) to 10 (highest cost, most difficult to borrow).
Markit starts to report DCBS data from October 2003, with the monthly frequency reported in 2003 and daily
frequency from 2004, so we use DCBS for our portfolio starting from 2004.
SIMILARITY Similarity, as in Hoberg and Phillips (2016).
STOCK RETURN R2 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 of 24
observations to estimate R2 , as in Hou et al. (2013).
ZERO RETURN DAYS The proportion of a firm’s daily returns over the past six months that are equal to zero as in Lesmond et al. (1999).

References

Akcigit, U., Celik, M.A., Greenwood, J., 2016. Buy, keep, or sell: economic growth and
the market for ideas. Econometrica 84 (3), 943–984.
Allison, J.R., Lemley, M.A., Schwartz, D.L., 2015. In: Our Divided Patent System, 82.
University of Chicago Law Review, pp. 1073–1154.
Allison, J.R., Lemley, M.A., Schwartz, D.L., 2018. How often do non-practicing entities
win patent suits? Berkeley Technol. Law J. 32, 237–310.
American Intellectual Property Law Association, 2015. Report of the economic sur-
vey 2015. Report.
Appel, I., Farre-Mensa, J., Simintzi, E., 2019. Patent trolls and startup employment. J.
Financ. Econ. 133 (3), 708–725.
Baumeister, R.F., Bratslavsky, E., Finkenauer, C., Vohs, K.D., 2001. Bad is stronger than
good. Rev. Gen. Psychol. 5 (4), 323–370.
Bena, J., Garlappi, L., 2020. Corporate innovation and returns. Rev. Corp. Finance
Stud. 9 (2), 340–383.
Beneish, M.D., Lee, C.M.C., Nichols, D.C., 2015. In short supply: short-sellers and
stock returns. J. Account. Econ. 60 (2), 33–57.
Bessen, J., Ford, J., Meurer, M.J., 2011. The private and social costs of patent trolls.
Regulation 34, 26–35.
Bessen, J., Meurer, M.J., 2012. The private costs of patent litigation. J. Law Econ. Pol-
icy 9, 59–96.
Bessen, J., Meurer, M.J., 2013. The patent litigation explosion. Loyola Univ. Chicago
Law J. 45, 102–145.
Bessen, J., Neuhäusler, P., Turner, J.L., Williams, J., 2018. Trends in private patent
costs and rents for publicly-traded United States firms. Int. Rev. Law Econ. 56,
53–69.
Bhagat, S., Brickley, J.A., Coles, J.L., 1994. The costs of inefficient bargaining and fi-
nancial distress. J. Financ. Econ. 35, 221–247.
Caskurlu, T., 2019. Effects of Patent Rights on Acquisitions and Small Firm R&D.
Working paper. University of Amsterdam.
Chan, L.K., Lakonishok, J., Sougiannis, T., 2001. The stock market valuation of re-
search and development expenditures. J. Finance 66, 2431–2456.
Chava, S., Nanda, V.K., Xiao, S.C., 2017. Lending to innovative firms. Rev. Corp. Fi-
nance Stud. 6, 234–289.
Chien, C., 2013. Startups and patent trolls. Stanf. Law Rev. 17, 461–506.
Choi, J.P., 1998. Patent litigation as an information-transmission mechanism. Am.
Econ. Rev. 88, 1249–1263.

16
F. Bereskin, P.-H. Hsu, W. Latham et al.
Cochrane, J.H., 2001. Asset Pricing. Princeton University Press, Princeton, NJ.
Cohen, L., Diether, K., Malloy, C., 2013. Misvaluing innovation. Rev. Financ. Stud. 26,
635–666.
Cohen, L., Gurun, U.G., Kominers, S.D., 2016a. Shielded Innovation. Working paper.
Harvard University and University of Texas at Dallas.
Cohen, L., Gurun, U.G., Kominers, S.D., 2016b. The growing problem of patent
trolling. Science 352, 521–522.
Cohen, L., Gurun, U.G., Kominers, S.D., 2019. Patent trolls: evidence from targeted
firms. Manag. Sci. 65 (12), 5461–5486.
Daniel, K., Hirshleifer, D., Sun, L., 2020. Short- and long-horizon behavioral factors.
Rev. Financ. Stud. 33, 1673–1736.
Eberhart, A.C., Maxwell, W.F., Siddique, A.R., 2004. An examination of long-term ab-
normal stock returns and operating performance. J. Finance 59, 623–650.
Fama, E.F., French, K.R., 1992. The cross-section of expected stock returns. J. Finance
47, 427–465.
Fama, E.F., French, K.R., 1993. Common risk factors in the returns on stocks and
bonds. J. Financ. Econ. 33, 3–56.
Fama, E.F., French, K.R., 2015. A five-factor asset pricing model. J. Financ. Econ. 117,
470–488.
Fama, E.F., MacBeth, J., 1973. Risk, return, and equilibrium: empirical tests. J. Pol.
Econ. 71, 607–636.
Feldman, R., 2014. Patent demands & startup companies: the view from the venture
capital community. Yale J. Law Technol. 16, 236–284.
Garcia, D., 2013. Sentiment during recessions. J. Finance 68 (3), 1267–1300.
Garleanu, N., Panageas, S., Yu, J., 2012. Technological growth and asset pricing. J.
Finance 67 (4), 1265–1292.
Gu, Lifeng, 2016. Product market competition, R&D investment, and stock returns. J.
Financ. Econ. 119, 441–455.
Hall, B.H., A. Jaffe, and M. Trajtenberg, 2001. The NBER patent citation data file:
lessons, insights, and methodological tools. Working paper, NBER.
Hall, B.H., Jaffe, A., Trajtenberg, M., 2005. Market value and patent citations. RAND
J. Econ. 36, 16–38.
Hall, B.H., Ziedonis, R.H., 2001. The patent paradox revisited: an Empirical study
of patenting in the U.S. semiconductor industry, 1979-1995. RAND J. Econ. 32,
101–128.
Hirshleifer, D., Hsu, P.-.H., Li, D., 2013. Innovative efficiency and stock returns. J. Fi-
nanc. Econ. 107, 632–654.
Hirshleifer, D., Hsu, P.-.H., Li, D., 2018. Innovative originality, profitability, and stock
returns. Rev. Financ. Stud. 31, 2553–2605.
Hoberg, G., Phillips, G., 2016. Text-based network industries and endogenous prod-
uct differentiation. J. Pol. Econ. 124 (5), 1423–1465.
Hobijn, B., Jovanovic, B., 2001. The information-technology revolution and the stock
market: evidence. Am. Econ. Rev. 91 (5), 1203–1220.
Hou, K., Peng, L., Xiong, W., 2013. Is R-squared a measure of market inefficiency?
Working paper. Ohio State University, City University of New York, and Prince-
ton University.
Hou, K., Xue, C., Zhang, L., 2015. Digesting anomalies: an investment approach. Rev.
Financ. Stud. 28, 650–705.
Hsu, P.-.H., 2009. Technological innovations and aggregate risk premiums. J. Financ.
Econ. 94 (2), 264–279.
Hsu, P.H., Lee, H.H., Zhou, T., 2022. Patent thickets, stock returns, and conditional
CAPM. Management Science 68 (11), 8343–8367.
Jaffe, A.B., Lerner, J., 2004. Innovation and Its Discontents: How Our Broken Patent
System Is Endangering Innovation and Progress, and What To Do About It.
Princeton University Press.
17
Journal of Banking and Finance 148 (2023) 106740
Kan, R., Robotti, C., Shanken, J., 2013. Pricing model performance and the two-pass
cross-sectional regression methodology. J. Finance 68, 2617–2649.
Kaplan, L., Zingales, L., 1997. Do investment-cash flow sensitivities provide useful
measures of financing constraints? Q. J. Econ. 112, 169–215.
Kesan, J.P., Ball, G.G., 2006. How are patent cases resolved? An empirical examina-
tion of the adjudication and settlement of patent disputes. Washington Univ.
Law Rev. 84, 237–312.
Kiebzak, S., Rafert, G., Tucker, C., 2016. The effect of patent litigation and patent
assertion entities on entrepreneurial activity. Res. Policy 45, 218–231.
Kogan, L., Papanikolaou, D., Seru, A., Stoffman, N., 2017. Technological innovation,
resource allocation, and growth. Q. J. Econ. 132, 665–712.
Laitner, J., Stolyarov, D., 2003. Technological change and the stock market. Am. Econ.
Rev. 93 (4), 1240–1267.
Lanjouw, J.O., Schankerman, M., 2004. Protecting intellectual property rights: are
small firms handicapped? J. Law Econ. 47, 45–74.
Lee, Jongsub, Seungjoon Oh, and Paula Suh, 2021. Inter-firm patent litigation and
innovation competition, working paper. https://ssrn.com/abstract=3298557
Lemley, M.A., Richardson, K., Oliver, E., 2019. The patent enforcement iceberg. Texas
Law Rev. 97, 801–833.
Lerner, J., 1995. Patenting in the shadow of competitors. J. Law Econ. 38, 463–495.
Lesmond, D., Ogden, J., Trzcinka, C., 1999. A New Estimate of Transaction Costs. Rev.
Financ. Stud. 12, 1113–1141.
Lev, B., 2001. Intangibles: Management, Measurement, and Reporting. Brookings In-
stitution Press, Washington, DC.
Lev, B., Sarath, B., Sougiannis, T., 2005. R&D reporting biases and their consequences.
Contemp. Account. Res. 22, 977–1026.
Lev, B., Sougiannis, T., 1996. The capitalization, amortization, and value-relevance of
R&D. J. Account. Econ. 21, 107–138.
Li, D., 2011. Financial constraints, R&D investment, and stock returns. Rev. Financ.
Stud. 24, 2974–3007.
Lin, X., 2012. Endogenous technological progress and the cross-section of stock re-
turns. J. Financ. Econ. 103 (2), 411–427.
Mann, W., 2018. Creditor rights and innovation: evidence from patent collateral. J.
Financ. Econ. 130 (1), 25–47.
Marco, A.C., Vishnubhakat, S., 2013. Certain patents. Yale J. Law Technol. 16,
103–133.
Noel, M., Schankerman, M., 2013. Strategic patenting and software innovation. J. Ind.
Econ. 61, 481–520.
Pástor, L., Veronesi, P., 2009. Technological revolutions and stock prices. Am. Econ.
Rev. 99 (4), 1451–1483.
Peters, Ryan H., Taylor, Lucian A., 2017. Intangible capital and the investment-q re-
lation. J. Financ. Econ. 123, 251–272.
Rozin, P., Royzman, E.B., 2001. Negativity bias, negativity dominance, and contagion.
Pers. Soc. Psychol. Rev. 5 (4), 296–320.
Shapiro, C., 20 0 0. Innovation policy and the economy. In: Jaffe, A.B., Lerner, J.,
Stern, S. (Eds.), Navigating the Patent thicket: Cross Licenses, Patent Pools, and
Standard Setting. MIT Press, Cambridge, MA.
Tetlock, P.C., 2007. Giving content to investor sentiment: the role of media in the
stock market. J. Finance 62 (3), 1139–1168.
Tucker, C., 2014. Patent trolls and technology diffusion: the case of medical imaging.
Working paper, MIT.
United States Government Accountability Office, 2013. Assessing factors that affect
patent infringement litigation could help improve patent quality. GAO-13-465.
Zhang, X.Frank, 2006. Information uncertainty and stock returns. J. Finance 61 (1),
105–137.