From litigation to innovation: Firms' ability to litigate and technological diversification through human capital

• Author: Puay Khoon Toh,Martin Ganco,Cameron D. Miller
• Date: 01 December 2020
• Published date: 01 December 2020
• DOI: http://doi.org/10.1002/smj.3203

RESEARCH ARTICLE

From litigation to innovation: Firms' ability

to litigate and technological diversification

through human capital

Martin Ganco

1

| Cameron D. Miller

2

| Puay Khoon Toh

3

1

Wisconsin School of Business, University

of Wisconsin-Madison, Madison,

Wisconsin

2

Whitman School of Management,

Syracuse University, Syracuse, New York

3

McCombs School of Business, University

of Texas at Austin, Austin, Texas

Correspondence

Cameron D. Miller, Whitman School of

Management, Syracuse University,

721 University Avenue, Syracuse, NY

13244-2450.

Email: cdmiller@syr.edu

Abstract

Research Summary: When firms diversify technologi-

cally, they often acquire human capital from competi-

tors. Legal challenges emerge when intellectual

property (IP) safeguards are involved. We examine a

firm's ability to initiate IP litigation or protect against

litigation (i.e., litigation ability) as an antecedent to its

technological diversification. We demonstrate that an

unexpected reduction in firm's litigation ability is asso-

ciated with a temporary decline in its entry into new

technological domains. Furthermore, we find that the

negative effect is stronger when the firm's existing

inventors cannot be easily utilized in the new domain

or when interfirm mobility in the new domain is low.

These findings extend prior work by highlighting a pro-

active role of the firm's litigation ability that spans

beyond protecting the firm's existing IP.

Managerial Summary: To diversify successfully, the

firm often needs new knowledge that can be acquired

by hiring new research personnel. However, these

inventors may come from competitors and their knowl-

edge may be protected by IP safeguards. We examine

how the firm's ability to initiate and protect against IP

litigation influences its technological diversification.

We find that an unexpected reduction in a firm's ability

to litigate temporarily reduces its expansion. The nega-

tive effect is magnified when considering expansion

into domains where the firm's existing inventors

Received: 15 November 2018 Revised: 4 May 2020 Accepted: 5 May 2020 Published on: 22 June 2020

DOI: 10.1002/smj.3203

2436 © 2020 John Wiley & Sons, Ltd. Strat Mgmt J. 2020;41:2436–2473.wileyonlinelibrary.com/journal/smj

cannot be utilized or where the intermobility of inven-

tors is low. Our findings suggest that the ability to both

protect IP and avoid litigation are important factors in

a firm's diversification strategy.

KEYWORDS

employee mobility, human capital, innovation, intellectual

property, litigation, technological diversification

1|INTRODUCTION

A firm often diversifies into new technological domains to introduce novel products or services

(Galunic & Rodan, 1998; Helfat & Raubitschek, 2000; Markides & Williamson, 1994; Pen-

rose, 1959). To enable such diversification, the firm may need more than to be able to leverage

its existing knowledge (Ahuja & Katila, 2001; Folta, Helfat, & Karim, 2016; Helfat &

Eisenhardt, 2004; Moeen, 2017); it could also need to access knowledge from the new domain

that it does not yet possess (Coff, 1997; Galunic & Rodan, 1998; Helfat & Raubitschek, 2000;

Kaiser, Kongsted, Laursen, & Ejsing, 2018; Miller, 2006; Rosenkopf & Almeida, 2003). The latter

presents complications when such knowledge is embodied primarily within human capital, a

phenomenon that is increasingly prevalent in knowledge-driven economies (Almeida &

Kogut, 1999; Grant, 1996; Phillips, 2002; Song, Almeida, & Wu, 2003). Past research has shed

much light on the former—issues about a firm utilizing its existing knowledge in new techno-

logical domains (Levinthal & Wu, 2010; Sakhartov & Folta, 2014), but paid less attention to the

latter, leaving open pressing questions about when the diversifying firm might face difficulties

when it tries to access such human capital.

The key complication is that the human capital in question usually resides within other firms

already operating in the focal domain, and there are intellectual property (IP) safeguards in place

to restrict the diversifying firm's access to it (Landes & Posner, 2003; Somaya, 2003; Starr, 2019).

Much of the knowledge contained within human capital is tacit and hence tied to its conduit,

leaving the diversifying firm with few options other than acquiring the human capital itself. Not

surprisingly, IP-related battles are frequently fought over employees moving across firms.

1

The

implications of human capital-related IP infringement litigation are nontrivial and they could

potentially curb the firm's decision to diversify in the first place.

2

Such an effect may be especially

salient if the firm is not equipped to deal with the ensuing IP-related battles. Yet, the literature

has largely been silent on this antecedent of technological diversification.

The extant literature on strategic IP litigation in technological competition (Tan &

Rider, 2017; Ziedonis, 2003) has mostly focused on how litigation protects the firm's existing IP.

This literature shows that a firm actively uses IP-related litigation to dissuade its valuable

employees from exit (Agarwal, Ganco, & Ziedonis, 2009; Ganco, Ziedonis, & Agarwal, 2015;

Starr, Ganco, & Campbell, 2018). A firm's ability to litigate over IP-related matters has thus

been conceptualized as a strategic lever (Agarwal et al., 2009; Clarkson & Toh, 2010). Thus far,

1

For instance, over 85% of federal trade secret lawsuits involve the firm's employees or business partners (Almeling,

Snyder, Sapoznikow, Mcollum, & Weader, 2010).

2

Plaintiffs received favorable decisions in 69% of trade secrete lawsuits (O'Connell, 2019).

GANCO ET AL.2437

though, our understanding of litigation ability has been confined within the purview of the firm's

current technological domains, specifically, how the firm uses its litigation ability to protect its

own existing human capital or the associated IP. The question of whether and how litigation abil-

ity may come into play in the firm's decision to diversify remains unexplored. Such an issue is

particularly salient when the firm is considering diversifying into technological domains where it

needs to acquire human capital and will likely have to deal with IP safeguards.

We attempt to fill this gap by asking the following questions. Does the firm's ability to litigate

affect its decision to diversify into a new technological domain?

3

If so, is this effect contingent upon

the characteristics of human capital needed within the new technological domain? We address

these questions by bringing together the literature on technological diversification, IP and

knowledge-intensive human capital to study the relationships between a temporary reduction

in the firm's ability to litigate, its decision to diversify technologically, and the characteristics of

human capital, specifically, the characteristics of inventors needed in the new technological

domain. Our main proposition is that a firm's loss of litigation ability will lower its likelihood of

diversifying into a new technological domain. Furthermore, we propose that this main effect

will be stronger (i.e., more negative) when the firm is less able to utilize its own existing inven-

tors in this new domain or when the cross-firm inventor mobility in the new domain is lower.

We empirically capture changes (reductions) in a focal firm's ability to litigate and defend

against IP infringement suits by exploiting unrelated exits, from 2002 to 2010, of firms' primary

IP law firms.

4

Our empirical strategy relies on the fact that it is typical for a firm to form a long-

lasting relationship with its primary law firm representing it in litigation.

5

Due to the complex

nature of IP litigation and highly specialized expertise of IP attorneys, these services are not eas-

ily replicated by individual mobile attorneys. Consequently, the focal firm's switching costs are

high, and the sudden exit of its law firm causes temporary reduction in its IP litigation ability.

We employ a variety of empirical specifications and robustness checks including a difference-

in-difference design to isolate the effects of the focal law firm exit firm from other potential con-

temporaneous influences. Empirically, we find results consistent with our theoretical predic-

tions. Verifying the key mechanism, we also find that the firm's litigation propensity decreases

shortly after the exit of its primary law firm. This helps to justify our use of the law firm exit as

a proxy for reductions in a focal firm's IP litigation abilities. We also confirm that the reduction

in the focal firm's overall patent filings upon the exit of its primary law firm is primarily attrib-

utable to its reduced diversification into new domains rather than to reduced patent filings in

its existing domains. The findings are thus driven by the firm holding back from diversifying

technologically rather than by the firm reducing its overall patenting activities.

6

3

As we describe below in more detail, we define the IP litigation ability as having means to both initiate an IP-related

litigation and to defend against IP-related lawsuits filed by other firms. The IP litigation ability is necessary for

enforcing existing IP (Ziedonis, 2003) or developing reputations for aggressive enforcement of IP (Agarwal et al.,2009).

4

We qualitatively examined the reasons for the law firm exit and selected only those that are plausibly exogenousto

their client firm characteristics. We elaborate on these details in a later section.

5

Through repeated interactions, the law firm's attorney team builds up expertise and familiarity with the focal firm's

technological portfolio and strategies. It becomes more efficient in providing focal-firm-specific legal services and more

effective in giving counsel on issues of risk and procedures during IP litigations and disputes over trade secrets, patents

or IP-related employment contract violations.

6

The broader issue which this finding is meant to address is that the observed reduction in a firm's patent filings

following the exit of its primary law firms could reflect a suppression of its patenting activities rather than its underlying

innovative activities related to technological diversification. We revisit this issue in greater details in a later section.

2438 GANCO ET AL.