Growth Option Behind Patenting BehaviorZuoqun Tang

School of Management, Zhejiang University,Hangzhou, 310027, P. R. China

Dengke JiSchool of Management, Zhejiang University,

Hangzhou, 210027, P. R. China

Abstract—We applied the Cox regression model to study thegrowth option impact on companies’ patenting behavior. Tomeasure the tendency of companies’ acquiring options in newtechnology field, we used the instant probability (hazard rate)when companies acquired the second options in new technologyfield. The reason why we did this is that we can differentiate thepatents acquired accidentally and those acquired strategically.So, we assume that when a company is to acquire the secondpatent in the new technology field, it tends to acquire the realoptions. As explanatory variables for patent behaviors, the scopeof opportunity, prior experience and the impact of competitionare used in this paper. The scope of opportunity is measuredby the number of rights asked by that patent, as well as thenumber of technological fields that the patent is categorized into.Generally speaking, the tendency of acquiring growth option ina new technology field that mirrored by patent behavior andthe scope of this opportunity are positively correlated. The priorexperience can be measured by the following two indexes: thefirst is the company’s cumulative option amount in the field ofmedicine when it acquires the first option in the new technologyfield, and this is used to test to what degree the company paysattention to the utility of owned options; and the second isthe company’s cumulative option amount in the fields excludingmedicine when it acquires the first option in the new technologyfield, and this is another way test to what degree the companypays attention to the utility of owned options. We assume thatthe tendency of a company’s acquiring growth option in a newtechnology field and the competition environment in the industryare negatively correlated.The empirical analysis results reveals that: first, the tendency of

a company’s using real options and the scope of the new technol-ogy’s application are positively correlated; second, the tendencyof a company’s acquiring real option in a new technology field andits history investment in this new technology field are negativelycorrelated; however, this negatively correlated relationship doesnot mean they have no relationship. Thirdly, the tendency of acompany’s acquiring real options in a new technology field andthe competition state in this new technology field are positivelycorrelated. That is to say, the amount of rivals and the patentthat they hold have obvious impact on the company’s acquiringpatent in the new technology field. Finally, similar to the researchby Pololny & Stuart(1995), the rivals influence the company’sacquiring patents the most, then the prior investing experience,and then the scope of opportunity of the new technology

I. INTRODUCTIONThe development and commercialization of medicine is a

long process with high cost, during which the pharmaceuticalcompanies have many decision points and on every pointthey can decide whether to cease the development and startmarketing or to keep investing into the product. Therefore,

National Natural Science Foundation of China (NSFC) project(No.70272039)

the R&D investment in pharmaceutical industry has a typicalcharacteristic of real option (Dixit & Pindyck1994). In thispaper, we collected the patent data between 1985 and 2003,but in our empirical analysis, only the data between 1990 and2003 was used to testify our hypotheses. The data between1985 and 1989 was just used to avoid left censoring so thatwe can make sure that we didn’t systematically delete the firstpatent before our observation period, or that we didn’t takethe third patent as the second just because the first one wasacquired before the observation period. As an analysis on thelevel of companies, our sample of 21 companies was selectedfrom the top 50 in Chinese pharmaceutical industry and thesequence was based on their sales volume in 2003.

II. LITERATURE REVIEW AND HYPOTHESISAs it is figured by Miller & Arikan (2004), the behavior

of the company’s investment shows more characteristics ofreal option actually. The analysis of the real option considersthe value of flexibility of management and path dependence(Kogut (1991,1994), Browman & Hurry (1993)).This article focuses on three factors: scope of opportunity

or standard deviation of the opportunity, the prior experience,the competition impact through the new product developing.Scope of opportunity: The strategic decision of entering a

new market undoubtedly involves some risks, and the key liesin whether this investment or the behavior of entering a newmarket is helpful to acquire some other potential opportunitiesof growth. Dixit & Pindyck (2002) figured that the way ofchecking if it involves the analyzing methods of the realoption is checking whether the exploration tendency of thereal investment decision is supported. Considering this, thefirst hypothesis of this article is: the tendency of a company’sacquiring growth option in a new technology field and scopeof opportunity in the industry are positively correlated.Prior experience: In some large pharmaceutical companies,

R&D department may run several projects that may be relatedto really a lot of technology fields simultaneously. So thedecisions of R&D investment are made on the condition of thecombination of investment. Hypothesis 2a: the tendency of acompany’s acquiring growth option in a new technology fieldand the investment environment in the industry are negativelycorrelated. Second, the effect of the combination of the optionsrefers to the experience collection in this field. The increase ofthe absorption ability makes it easier to absorb new knowledgeCohen & Levinthal, 1990. Based the discussion above, if acompany has the option in a field, they will be positive to

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continue their investment in this field. Hypothesis 2b of thisarticle is: the tendency of a company’s acquiring growth optionin a new technology field and experience collected in theformer industry are negatively correlated.The attractive market opportunities will attract the competi-

tors certainly, and this makes it confusing for decision makerswhen making investment decisions: on the one hand, the optionthat could be used in several attractive fields may be morevaluable, but on the other hand, the competitors will find theopportunities also, and they will invest in this field to get theoption. Investment in the new product development field willincrease the level of knowledge in this field. Hypothesis 3:the tendency of a company’s acquiring growth option in anew technology field and competition state in the industry arepositively correlated..

III. DATA AND SAMPLESTo measure the tendency of companies’ acquiring options in

new technology field, we used the instant probability (hazardrate) when companies acquired the second options in newtechnology field. Generally speaking, the tendency of acquiringgrowth option in a new technology field that mirrored bypatent behavior and the scope of this opportunity are positivelycorrelated. The prior experience can be measured by thefollowing two indexes: the first is the company’s cumulativeoption amount in the field of medicine when it acquires the firstoption in the new technology field, and this is used to test towhat degree the company pays attention to the utility of ownedoptions; and the second is the company’s cumulative optionamount in the fields excluding medicine when it acquires thefirst option in the new technology field, and this is anotherway test to what degree the company pays attention to theutility of owned options. We assume that on the one hand,a large scope of opportunity in the new technology field canmotivate the company to do more explorative research, and onthe other hand the past successful explorative research mayhave some impact on the company’s research in another newfield and the company is more apt to make some exploitationon the present research achievement. Therefore, the tendencyof a company’s acquiring growth option in a new technologyfield and its cumulative investing experience are negativelycorrelated. As to the impact of competition, we can test it fromthe following two angles: the first is the average option amountheld by each competitor because this reveals their how muchthey have invested; if the competitors input little, it meansthe market is quite shallow and it has little attractiveness forthe new-enterers and if the competitors have an over-amountof options, it indicates that the competition is overheated,and likewise it has little attractiveness for the new-enterers;and the second is the amount of competitors when a certaincompany acquires the first option. We assume that the tendencyof a company’s acquiring growth option in a new technologyfield and the competition state in the industry are negativelycorrelated.The analysis unit is the single patent at the level of

company. In this research, we just consider the patent data

of the mainland of China, and the source of these data isdatabase of the State Intellectual Property Office of P. R. China(http://www.sipo.gov.cn/sipo/zljs/default.htm).In addition, Chinese Pharmaceutical Company Management

Association listed the 100 strongest pharmaceutical companiesof China 2004 by the sales amount of 2003. To meet theresearch needs, we focus on 21 companies picked out ofthe first 50 strongest pharmaceutical companies, based on thestate of acquiring the data of patents. Some figures of theChinese Pharmaceutical companies show the place, sales andthe patent-acquiring state.

IV. MODELS AND VARIABLE SPECIFICATIONS

The explanatory variables in this empirical analysis are acompany’s of acquiring a patent in a new technology field.The scope of opportunity: The potential impacts that a

company invests to acquire the second option in a new field canbe measured by the scope of opportunity of the first acquiredoption. The larger the scope of opportunity is, the moretechnical fields the option could be applied into. We measurethe scope of opportunity with two indices: the number of rightsasked for: According to the “Rules for Implementation of thePatent Law of the People’s Republic of China”, the claimsshould describe the technical characteristics and the extentof the patent protection asked for clearly and briefly. Thepotentially applicable fields could be reflected by the scopeof opportunity of a patent option. The rights asked for couldalso reflect the scope of the patent impact. For a patent option,asking for more rights means more fields that the patent couldbe applied into. This can magnify the standard deviation ofthe patent’s potential benefits and increase the value of thepatents furthermore. To measure the extent of the patent’spotential impact, we use the number of rights asked for; andtotal potentials: According to Rossenkopf & Nerkar (2001) andShane (2001), the more fields a patent is categorized into, thelarger the scope of opportunity is. So we measure the option’sscope of opportunity by testing the number of the technicalfields the patent is categorized into.The prior experience: the scope of prior investment: This

index can be measured by the number of the company’stechnical fields. Generally, the more options acquired bya company, the more attention the company puts into thedeadline and invalidation of the options (Rita McGrath & AtulNerkar2004); and the accumulative investment experience: Itcould be measured by the following two indices: (a) theoptions in pharmaceutical industries: It is measured by thenumber of a company’s cumulative options in pharmaceuticalfield when the company acquired the first option in a newtechnical field. This is mainly to test how much a companypays attention to the utility of real options. (b) The options innon-pharmaceutical fields: This is measured by the number ofa company’s cumulative options in non-pharmaceutical fieldswhen the company acquired the first option in a new technicalfield. This is another way to test how much a company paysattention to the utility of real options.

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The impact of competition: we can measure it from thefollowing two perspectives: the competitors’ investment: Itis measured by the average amount of options held by eachcompetitor when the company acquired the first option in anew technical field. If the competitors input little, it meansthe market is quite shallow and it has little attractiveness forthe new-enterers. If the competitors have an over-amount ofoptions, it indicates that the competition is overheated, and ithas little attractiveness for the new-enterers; and the amountof competitors: It is measured by the amount of competitors ina certain field when the company acquired the first option inthe new technical field. The competitors mean any organizationthat owns patent in the field, including nonprofit organizations,a university for example.

V. RESULTS AND ANALYSISIn the first model, we include only the two indices that

measure the attractiveness of the patents, which are the numberof patent rights and the potential influence fields. The twoindices reflect the probable application scope. The table tellsus that the log likelihood increases dramatically comparedwith benchmarking risk function. Besides, the parameter es-timations of the two indices differ much from 0. And thissupports the Hypothesis 1, that the tendency of acquiringpatents (real options) and the probable application fields arepositively correlated.The second model includes only the variable “prior in-

vestment scope” that reflects the prior investment experience.The log likelihood also increases dramatically. Besides, theparameter estimation is minus and differs much from 0. Thissupports Hypothesis 2a, that the tendency of a company’sacquiring real option in a new technical field and its historyinvestment in this technical field are negatively correlated.The third model includes only the variable that measures the

cumulative investment experience of a company. The statisticsand analysis tell us that the tendency of a company’s acquiringreal options in a new technical field and the cumulative invest-ment experience in the former field are negatively correlated,instead of being totally unrelated according to net present valueanalysis.The fourth model includes only the two variables-the com-

petitors’ investment and the number of competitors-that mea-sure the impact of competition. The parameter estimations areboth positive and differ much from 0. The result supports thehypothesis. The log likelihood increases dramatically com-pared with benchmarking risk function. The model 4 showsthat the tendency of a company’s acquiring real options ina new technical field and the competition state in this newtechnical field are positively correlated. That is to say, theamount of rivals and the patent that they hold have obviousimpact on the company’s acquiring patent in the new technicalfield.The fifth model includes all the influential variables. The

result shows that the log likelihood increases dramaticallycompared with benchmarking risk function. The parameterestimations differ much from 0. This supports Hypothesis 1,2

and3 effectively. Besides, we could know to what degree theseinfluential variables impact the tendency of acquiring patents(real options). For example, if the average of potential influen-tial fields increases by 10%, the hazard rate of acquiring patentwill increase by 6.48% (exp(0.0339× 1.683110 = 1.0648%)).And if the average of competitors’ investment increases by10%, the hazard rate of acquiring patent will increase by 51.6%(exp(0.2033× 1.861× 110%) = 1.516). In another word, theimpact of the competitors’ investment is 7.96 times of thatof the potential influence fields on the tendency of acquiringpatent. Furthermore, we can draw a conclusion from the tablethat, the rivals influence the company’s acquiring patents themost, the prior investment experience comes next, and thescope of opportunity of the new technology the least. It issimilar to the result of the research by Pololny & Stuart(1995).They advanced that technical attractiveness is not the onlyreason that urges a company enter into a new field.In addition, the value of options decreases, and the potential

value of basic knowledge becomes easy to evaluate when theuncertainty is exposed gradually. This means that in the earlystage of the technical development, the more companies whichacquired real options, the more urgent the companies wantto acquire real options. When the technology becomes moresophisticated, keeping on investment is attractive only for thecompanies who can put options in practice and therefore gainsan advantaged position in competition. For other companies, itis a rational choice to cease the option or to give up investmentor to cooperate with other advantaged companies. So theoption theory advanced that competition not only imposespressure to add more resource. Instead, a company shouldadjust strategy on the basis of reducing uncertainty and re-distributing resource. The technical cooperation and overflowof rivals’ research could bring some positive impact. And thecompetition may also bring some bad impact. Both of theseimpacts may influence a company’s entering into a new field.So the impact of competition is nonlinear.This work constructs model 6-8 to analyze the nonlinear

impact. The models use two variables, the square of the rivals’investment and the square of the number of competitors. Themodel 6 and 7 analyze the impact of investment of rivals andnumber of competitions. The model 8 analyzes the combinedimpact of the rivals’ investment and the number of competitors.The results support the nonlinear correlation between thetendency of acquiring a patent and competition.

VI. CONCLUSIONSIn the sections above, we analyzed R&D investment behav-

iors of some typical companies in pharmaceutical industry. Itleads us to the conclusion that the strategy decision makersuse ROR analysis in uncertain conditions consciously or sub-consciously.The empirical analysis results reveal that: firstly, the ten-

dency of a company’s acquiring patents (real options) in anew technical field and the scope of the new technology’sapplication are positively correlated; secondly, the tendencyof a company’s acquiring real option in a new technology

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TABLE ITHE REGRESSION COEFFICIENT OF THE 7 VARIABLES

95% CI for Exp (B)Variables N Mean S. E. df Sig Exp (B)Lower Upper

The number of rights 221 1.171 0.810 1 0.043 3.225 0.284 36.612The potential influence fields 221 1.683 1.440 1 0.031 5.382 0.072 404.6The scope of prior investments 221 5.006 2.863 1 0.023 149.3 0.028 802100The number of patents in phar-maceutical fields 221 11.874 9.224 1 0.014 143487 0 5.1× 10e6The number of patents in non-pharmaceutical fields 221 28.641 32.76 1 0.010 2.75× 10e12 0 3.1× 10e14The competitors’ investment 221 1.861 0.717 1 0.023 6.430 0.748 55.257The number of competitors 221 7.334 6.042 1 0.032 1531.5 0 1.1× 10e4

field and its history investment in this new technical field arenegatively correlated. Besides, the tendency of a company’sacquiring real options in a new technology field and the cumu-lative investment experience in the former field are negativelycorrelated, not totally unrelated according to net present valueanalysis. Thirdly, the tendency of a company’s acquiring realoptions in a new technology field and the competition statein this new technology field are positively correlated. That isto say, the amount of rivals and the patent that they holdhave obvious impact on the company’s acquiring patent inthe new technical field. Finally, similarly to the result of theresearch by Pololny & Stuart(1995), the rivals influence thecompany’s acquiring patents the most , the prior investmentexperience comes next, and the scope of opportunity of thenew technology the least.

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