Patent Premium of Foreign Firms Innovating in Weak IPR Emerging MarketsAbstractThe weak intellectual property rights (IPR) protection in emerging markets pose a critical challenge for foreign firms attempting to appropriate returns from innovation in these markets. This study investigates to what extent, if at all, foreign firms in emerging markets obtain patent premium, defined as incremental productivity gains from a firms patents compared with its productivity had the firm not owned any patents. Drawing on theoretical insights from the Profit from Innovation framework, the institutional theory and liability of foreignness (LOF) logic, and using a panel data set of 32,901 firms in Chinas high-tech industries, we find that foreign firms do obtain patent premium despite the weak IPR protection in the country. However, the level of patent premium is significantly lower for foreign firms than for domestic firms, consistent with the LOF logic. We also find that foreign firms patent premium increases substantially with institutional development, and more so among wholly owned foreign subsidiaries (WOSs) vis-vis international joint ventures (IJVs). This offers further support for the LOF logic as institutional development lowers LOF for foreign firms, particularly for WOSs. These findings provide implications to foreign firms regarding their innovation strategies in weak IPR emerging markets and to host country governments in making their innovation policies. Keywords: Patent premium, IPR, innovation, institutions, emerging economyINTRODUCTIONIt has been a big paradoxical question to both scholars and executives alike for some time: Can innovation and patents pay off for foreign firms competing in large emerging markets where market opportunities are enormous yet intellectual property rights (IPR) protection is rather limited? The last decade has witnessed a surge of innovation activities of multinational enterprises (MNEs) competing in foreign emerging markets (Qu et al., 2013; Thursby and Thursby, 2006; Zhao, 2006). Patent statistics reveals that the number of invention patent applications received by the National Intellectual Property Administration of China (CNIPA), for instance, increased from 63,000 in 2001 to 1.54 million in 2018, producing a staggering 24-fold growth. China surpassed the US since 2011 becoming the worlds biggest country in receiving patent applications.This phenomenon is striking considering the weak institutional environment and IPR protection in these economies (Brander et al., 2017; Peng et al., 2017). According to the Profit from Innovation (PFI) framework literature, patenting as a formal appropriation mechanism may not be viable in the emerging economies where law enforcement for IPR is weak (Al-Aali & Teece, 2013), because the effectiveness of patenting primarily depends on the quality of national law system and institutional environment in which firms operate (Schankerman, 1998; Somaya, 2012). In such cases, innovators may count on other informal appropriation mechanisms, such as secrecy, control of complementary resources, or taking an advantage of lead time (“first to market”) to capture value from innovations (Al-Aali & Teece, 2013; Hall et al., 2014). The weak IPR protection leads to weak incentives to patent and therefore poses a critical challenge for MNEs attempting to appropriate returns from patenting in emerging economies.This paradox has prompted researchers to investigate the conditions that are motivating the rapid growth of patenting in these countries (Hu, 2010; Hu and Jefferson, 2009; Keupp et al., 2012; Li, 2012). It has been recognized that market size and economic advancement may offset some disincentives of patenting activities caused by weak IPR protection (Huang and Jacob, 2014), and governmental support for innovation (e.g., favorable tax treatment and R&D subsidy) may incentivize firm-level patenting activities despite the existence of patent infringement (Huang, 2017; Li, 2012). Others also suggest that improved physical infrastructure and geographic clusters for innovation are conduits of patenting undertaking (Hu and Mathews, 2005; Porter and Stern, 2001). Despite these scholarly efforts, it remains unanswered to what extent, if at all, patenting is valuable for foreign firms investing in large emerging markets characterized with weak IPR protection. Combining insights from the PFI framework, institutional theory and liability of foreignness logic (LOF), we aim to assess how valuable patenting is for foreign firms in these economies. We denote the value of patenting by patent premium, generally referring to increment to the value of technological innovations realized by patenting them (Arora et al., 2008)Arora, 2008, R&D and the Patent Premium;Arora, 2008, R&D and the Patent PremiumArora, 2008, R&D and the Patent Premium;Jensen, 2011, Estimating the patent premium: Evidence from the Australian Inventor Survey, and specifically in this study connotes to incremental productivity gains from a firms patents compared with its productivity had the firm not owned any patents. The ideal method to estimate patent premium is to compare productivity of a patent-owning firm with its productivity had the firm not owned any patents, but the productivity of a patent-owing firm had it not owned any patents is hard to observe. In order to provide robust evidence, we employ a matching and difference-in-difference method on a large dataset of high-technology (high-tech) companies competing in China, the largest emerging market that features well with market opportunities and weak IPR protection in most sectors. We construct the dataset by matching the data from Chinas National Bureau of Statistics Annual Survey of Industrial Enterprises with the patent data from the National Intellectual Property Administration of China (CNIPA). The dataset covers 32,901 firms in Chinas high-tech industries (in which foreign firms actively operate) during a ten-year period of 1998-2007.Our longitudinal analysis offers some interesting and important insights. First, we find a significantly positive patent premium among foreign firms despite weak IPR system in China, validating the extensive patenting activities of foreign firms in the country. Second, foreign firms obtain lower patent premium than domestic firms, informing the presence of LOF and disadvantage of foreign firms vis-vis their domestic peers in appropriating returns from patents and transforming technological innovation to productivity gains in emerging markets. Third, institutional development can effectively reduce LOF of foreign firms, hence foreign firms patent premium increases substantially with institutional development, and more so among wholly owned foreign subsidiaries (WOSs) vis-vis international joint ventures (IJVs). This offers further support for the LOF logic as institutional development lowers LOF for foreign firms, particularly for WOSs. Surprisingly, we find that patent premium of domestic firms decreases with institutional development, indicating that domestic firms may encounter a deterioration in their advantage of localness with institutional development. This study makes important contributions to the literature. First, why a firm with a given innovation would prefer formal over informal IPR or vice versa is an important question related to the firms strategy of profiting from innovation. Most of the previous studies (Arundel and Kabla, 1998; Levin et al., 1985; Cohen et al., 2000; Graham and Sichelman, 2008) provided evidence in the context of developed economies, where the institution is mature and robust. However, this important question in the setting of emerging economies where the IPR systems are weak remain under-studied. To our best knowledge, this study is the first to empirically assess patent premium in an emerging economy. By presenting a significantly positive patent premium among foreign firms operating in a large emerging economy, our findings reveal that foreign firms can gain higher productivity with patenting vis-vis without patenting. Thus patenting can be a viable appropriation mechanism for foreign firms to profit from innovation, even in large emerging markets with weak IPR systems. As such, our study addresses the paradox between the facts of rapidly growing patenting activity and weak IP protection in a large emerging economy, that is China.Second, The concept of liability of foreignness (LOF) describes that multinational corporations incur additional cost in comparison to domestic competitors when operating in foreign markets. One of the sources of LOF is foreign firms inadequate knowledge of the host countrys culture, norms, values and business practices, which is referred as “unfamiliarity hazards” (Eden and Miller, 2001). Along with culture, norms, values and practices, unfamiliarity with formal institutions such as laws, regulations, constitutions, contracts, property rights in host countries may also lead to LOF. Our study contributes to the literature of LOF by arguing that LOF plays a key role driving different levels of patent premium for firms with varying ownership types. We discover higher patent premium of domestic firms than that of foreign firms, which can be explained by higher LOF faced by foreign firms than domestic firms. Further, we report higher increase of patent premium for wholly owned subsidiaries (WOSs) than for international joint ventures (IJVs) with institutional development. This similarly confirms the significance of LOF because WOSs generally suffer more LOF than IJVs, but as institution develops, WOSs are able to reap more benefit than IJVs. Overall, these findings provide strong evidence that LOF is a key mechanism through which a firms ownership type moderates its level of patent premium. THEORETICAL DEVELOPMENTPatenting under Weak IPR ProtectionPatenting has long been recognized as a differentiating mechanism, providing owners with the right to exclude others from using the invention without their permission for a limited period (Mansfield, 1986; Ziedonis, 2004). The exclusionary power of patent rights can bring market power (Bessen, 2009) and allow firms to pursue additional profit opportunities and competitive advantage (Gambardella, 2013; Somaya, 2012). While this logic generally applies to firms in every country, actual returns or benefits of patenting will significantly vary depending on institutional and market environments. Perhaps, there is no country that brings in such complexity and paradox for firms to deal with patenting activities as large emerging economies like China and India. Markets are huge yet IPR protection remains weak. Albeit some of these governments have been making efforts in protecting patent rights, especially after joining the World Trade Organization (WTO), legal enforcement of IPR protection is impeded by a plentitude of perilous issues such as public empathy of copycatting (Luo et al., 2011), weak judiciary and administrative systems in IPR (Bosworth and Yang, 2000; Wang, 2004), business and public sector corruption (Kshetri, 2009; Liu, 2006), and political and institutional instability (Lieberthal and Lieberthal, 2003). Such institutional voids or hardships relating to patenting activities are further exacerbated by lack of institutional transparency and limited and often selective enforcement of IPR law (Khanna and Palepu, 2013; Ostergard, 2000; Oxley, 1999). This makes it difficult to appropriate returns from innovation through patent protection (Al-Aali and Teece, 2013; Schankerman, 1998; Teece, 1986). Despite enormous institutional challenges, firms in large emerging markets are likely to benefit from patenting, because firms can seize competitive opportunities of patenting associated with governments innovation subsidies on the one hand and access to certain privileged market on the other which can offset the hindering effect of institutional hazards (Luo, 2006; Zhang et al., 2009). In addition, firms can employ relationship-based strategies, through which they leverage managers interpersonal ties and firms interorganizational relationships with government agencies and officials and legal professionals such as judges and lawyers to overcome the institutional challenges (Somaya, 2012; Keupp et al., 2009; Peng and Heath, 1996; Luo, 2001; Peng, 2003). With regards to competitive opportunity of patenting, the governments in large emerging economies such as China commonly promote high-tech innovation through providing incentives and subsidies to high-tech companies, which include tax subsidies (e.g., 15% tax rate for high-tech companies versus the standard 25% tax rate), preferential loans, grants, human resources support, and favorable input prices and distribution channels (Capital Trade Incorporated, 2009; Dang and Motohashi, 2015; Hao et al., 2014). For a company to be qualified for the subsidies, it would need to obtain high-tech-enterprise status which is determined by whether the company own local IPR such as patents (Ministry of Science and Technology, 2016). These subsidies can directly cut cost hence contribute to productivity gains of qualified companies. The high-tech company status also provides these companies the access to government procurement contracts and other privileged market opportunities. Thus patenting, as a pre-requisite for the high-tech company status and governments subsidies, can be highly valuable for companies, both foreign and domestic alike, in these large emerging markets. In addition to directly benefiting from owning patents, companies can employ relationship-based strategy to protect against patent infringement and secure productivity gains from patents. For instance, by hosting professional workshops and seminars open to local government officials, firms may gain better recognition and are more likely to be regarded as deserving IPR protection in case of patent infringements (Keupp et al., 2009). In patent litigations, firms can engage in strategies and tactics to gain the favor of government agencies or courts in terms of patent enforcement (Somaya, 2012). In addition to the legal route, patent rights in China can be enforced through the administrative channel. Local patent administration authorities can investigate infringement cases, determine possible infringements and order injunctions should an infringement be determined. Good relationships with the administrative staff in these government agencies can prompt them to act quickly against IPR infringements without lengthy and expensive court trials (Keupp et al., 2009). Similarly, close ties with legal experts provide firms with reliable access to important legal, political or locality-specific knowledge and resources in patent litigations. Firms can target at specific tribunals or courts for patent enforcement if the firms are aware of any perceived policy bias or specialization in patent law at these tribunals or courts (Moore, 2002; Somaya and McDaniel, 2012). Because transaction costs in dealing with infringement and litigation are higher in emerging economies (Meyer et al., 2009), these strategies are important for firms to mitigate litigation cost and lead to productivity gain of patent.As detailed below, we first hypothesize how patent premium varies between foreign and domestic firms per the LOF logic. Then we probe how institutional development influence patent premium and compare the influence of institutional development between foreign and domestic firms, and across foreign firms of different ownership types (IJVs versus WOSs), again via the LOF logic. Finally, we chose a host of high-tech industries as our specific analytical setting as it is the one in which foreign firms have been actively competing with local firms yet it is the one that is highly susceptible to IPR infringement.Patent Premium of Foreign vs. Domestic FirmsSubsidiaries of foreign multinationals are distinct from indigenous firms because they face considerable liabilities of “foreignness” (Zaheer, 1995) and “outsidership” (Johanson and Vahlne, 2009) in host economies. LOF induces extra costs to MNCs operating in an overseas market that would not incur to local firms (Zaheer, 1995), thus is expected to have a negative impact on MNC performance such as lower profitability and lower survival rate than local firms, ceteris paribus (Luo et al., 2002; Zaheer and Mosakowski, 1997). LOF is particularly high in emerging markets due to the uncertain and unpredictable environment there (Luo et al., 2002) and dissimilar institutions between MNCs developed home country and emerging markets (Kostova and Zaheer, 1999).Per the LOF logic, we expect that foreign firms patenting premium will be lower than local firms due to foreign firms extra difficulties, challenges and costs in acquiring competitive opportunities from owning patents and utilizing relationship-based strategies to enforce patent rights. Firms can obtain patent premium through various subsidies, support and innovation policies of host governments. Foreign firms, however, encounter more difficulties and are less likely to gain the supports and subsidies than their domestic peers (Office of the United States Trade Representative, 2018). For instance, some foreign firms may be unable to transfer ownership of patents that are used globally to their Chinese subsidiaries in ways that would allow them to obtain high-tech company status (The US-China Business Council, 2013). Other foreign firms report significant challenges in applying for high-tech company status due to inconsistent accreditation process in different provinces, or unstable application procedures with some provinces revising rules and other provinces tightening criteria (The US-China Business Council, 2013). Sometimes governments innovation policies and subsidy and market acce