Innovation, Intellectual Property, and the Role of External Forces

Innovators must decide on an innovation strategy and how to protect their innovations from potential competitors. While the two decisions are related, they are not identical, and there is no guarantee that changes in the propensity to innovate must be reflected by changes in the propensity to protect. I separate a firm’s innovation and intellectual property (IP) protection decisions and enrich her choices by allowing for multiple possible methods of IP protection. I find that the potential for competition in a firm’s industry reduces the incentives to create a market through innovation, but it increases the use of IP should innovation be successful. These two channels combine so that industry competition has a broadly inverse–U shaped relationship with observed patenting, but a normal–U relationship with actual innovation. Here, the average quality of a firm’s patent portfolio is a better proxy for innovation: when incentives to patent are low and innovative effort is high, firms only other to file high–quality patents. JEL–Classification: K11, L24, O31, O34