Do formal and informal protection methods affect firms' productivity and financial performance?

• Author: Naqeeb Ur Rehman,Fei Yu
• DOI: http://doi.org/10.1111/jwip.12092
• Date: 01 November 2018
• Published date: 01 November 2018

DOI: 10.1111/jwip.12092

ORIGINAL ARTICLE

Do formal and informal protection methods

affect firms' productivity and financial

performance?

Naqeeb Ur Rehman

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Fei Yu

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1

Faculty of Economics and Administrative

Sciences, Epoka University, Tirana, Albania

2

Tsinghua University, Tsinghua, China

Correspondence

Naqeeb Ur Rehman, Faculty of Economics

and Administrative Sciences, Epoka

University, Tirana, Albania.

Email: nrehman@epoka.edu.al

The main objective of this paper is to investigate the direct

relationship between formal and informal protection meth-

ods and firms' productivity and financial performance. This

study used Chilean firms' level data. The principal findings

are that micro, small and medium-sized enterprises (MSMEs)

with informal protection methods positively influence

productivity and financial performance. Moreover, the

results show that formal and informal protection methods

are interconnected. Their joint effect accelerates firms'

productivity and makes financial performance stronger as

compared to using a single protection method. This outcome

is robust across SMEs and large firms. Thus, this finding

suggests that using a combination of formal and informal

protection method benefits firms' productivity and financial

performance. The managerial implications of this study

suggest that business managers/owners could use multiple

protection methods (a mix of formal and informal) to

increase their firms' productivity and profitability. In

addition, to support innovation in Chilean firms, economic

policies must encourage innovation in small businesses

through subsidies (tax credits) and R&D grants, as well as

awareness of the use of protection methods.

KEYWORDS

productivity and financial performance, protection methods

© 2018 The Authors. The Journal of World Intellectual Property © 2018 John Wiley & Sons Ltd

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wileyonlinelibrary.com/journal/jwip J World Intellect Prop. 2018;21:270–288.

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INTRODUCTION

Intellectual property rights (IPRs) are effective tools for protecting firms' innovation output from imitation. These IPRs

are also known as protection methods in the innovation literature. Protections methods not only generate additional

revenues for firms but also provide them with strategic competitive advantage (see, Spithoven, Vanhaverbeke, &

Roijakkers, 2013). This study focuses on firm's formal (requiring legal measures with registration costs) and informal

(based on trust and relationship and not requiring registration costs) protection methods and their association with

firm's productivity and financial performance. In order to protect innovation, firms use different combinations of

formal (patents, copyrights, and trademarks) and informal (secrecy and confidentiality agreements) methods (Hall,

Helmers, Rogers, & Sena, 2014). However, for a firm, the choice between formal and informal protection methods

depends on the innovation output. For instance, many firms prefer to use patents for product innovation and secrecy

for process innovation. Similarly, firms' adoption of formal and informal protection methods may also depend on the

degree of novelty of the innovation. A firm can use patents for a radical innovation (new to the world) and secrecy for

incremental type of innovations (new to the business) (see Hanel, 2008). However, both formal and informal methods

require costs: patents are usually expensive, and for secrecy or confidentiality agreements firms may require active

knowledge management in the form of internal secrecy policy (see Hall et al., 2014).

Regarding the benefits of protection methods, these methods (patents, trademark, copyrights, utility model,

secrecy etc.) reduce information asymmetry and it is easy for small firms to secure external credit backed by IPRs

(Rossenfosse, 2012); increase firms' revenue through monopoly power and could help domestic economy in securing

foreign direct investment (Yang, Huang, & Lin, 2014). Moreover, protection methods discourage imitation and

increase employees' loyalty through the reputational incentives (Thoma & Zimmermann, 2013). Further, Hagedoorn

and Zobel (2015) empirical study of 101 manufacturing firms concludes that firms with strong protection methods

(patents, copy rights, brands, and trade secrecy) are more likely to engage in open innovation activities with customers,

suppliers and competitors. Such protection methods not only protect knowledge but also encourage open firms to

exchange that knowledge with external partners in order to value their innovation output.

In short, the aim of this empirical study is to examine the direct relationship between protection methods (formal

and informal) and firms' productivity and financial performance. Based on Chilean micro level data, these formal

(patents, utility models, branding, and plant variety methods etc.) and informal (secrecy and confidentiality

agreements) protection methods represent the importance of property rights to firms, as measured on a Likert scale.

This study is novel and contributes to the existing knowledge in several ways. First, previous studies (Jensen &

Webster, 2006; Passi & Valkokari, 2010; Thoma & Bizer, 2013) neglected to make a direct estimation of the relation

between protection methods (both formal and informal) and Chilean firms' performance. Second, past studies reveal a

research gap in terms of empirical analysis of the interrelation between formal and informal protection methods and

their joint effect on Chilean firms' performance. To measure the firms' performance, two proxies have been used; first,

productivity (total factor productivity) and second, financial performance (net profit margin). Profitability ratio is

crucial for firms' long term existence and it is regarded as a major source of small firms' capital when considering their

external constraint. Further, protection methods are connected to firms' output, that is, increasing their productivity

and thus profiting from their innovation. To analyze the impact of protection methods on firms' performance, the data

were split into four size categories, that is, micro, small, medium (MSMEs), and large enterprises. This strategy

investigates the link between protection methods and firms' performance more appropriately than taking a single size

of firm'. Overall, the research paper formulated the following research questions: Do formal and informal protection

methods affect firms' productivity and financial performance? and, How the interrelation between formal and

informal protection affect firms' productivity and financial performance?

Concerning the empirical approach, this paper uses a Tobit regression model (based on censored data) to analyze

the relationship between protection methods and firms' productivity and financial performance. The principal

outcome of the Tobit regression analysis suggests that informal protection methods positively affect SMEs'

productivity and financial performance more than they domore those of large firms. However, no association is found

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