Debt Financing to Innovative Firms: Evidence from First Action Reports on Patent Applications

Abstract

I examine the causal impact of initial patent reviews on firms’ subsequent debt financing. I collect data on patent examiners’ first action reports from the U.S. Patent and Trademark Office. These initial reports reveal the merits of an invention at an early stage in the multi-year patent application process and signal the likelihood of future patent approval. To separate the net causal impact of initial patent reviews from the underlying invention quality, I use examiners’ propensity to approve an application as an instrument. I predict and find that better initial patent review outcomes improve firms’ subsequent loan financing outcomes, including higher borrowing capacity, broader banking relationships, and more favorable loan contract terms. I further show an increase in future operating cash flow and a reduction in information asymmetry as channels through which favorable patent reviews alleviate loan financing problems. Altogether, I provide evidence that the patenting process mitigates debt financing problems for innovative firms and facilitates lending. At a higher level, I highlight the importance of accounting intangibles, which is incremental to economic intangibles.