How Private Firms Impact Public Firm Innovations

Public firms account for most of the patent production in the U.S., but young, private firms play a critical role in supplying novel and high-impact innovation. Moreover, the impact of R&D extends beyond individual firms, as investment decisions often generate spillovers that benefit others operating in similar technology spaces. To date, most of the literature has focused on spillovers either between public firms or private firms, but in practice, spillovers occur across all firms regardless of their public or private status. 

In a new paper, “Learning from the Little Guy: Innovation Spillovers from Private to Public Firms”, we examine how technology spillovers from young, private firms influence innovation in public firms. While spillovers between public firms have been widely studied, we examine private firms for two reasons. First, private markets are often assumed to provide little for public firms to learn from. Unlike public companies, private firms are not subject to mandatory disclosure requirements, nor do they offer benefits that come with price informativeness, analyst coverage and market scrutiny. However, private firms patent their innovations, and patenting itself is a form of technological disclosure. These patents contribute to the broader information environment, even in the absence of traditional public reporting.

Second, young private firms tend to produce more novel and breakthrough innovations than their public counterparts. Unburdened by short-term market pressures or dispersed shareholder oversight, they are better positioned to pursue high-risk, long-term ideas. Many also choose to remain private longer, especially those with significant intangible capital. Neglecting such innovative firms understates the extent of spillovers. 

How public firms are impacted by young, private firms is ex ante unclear. On one hand, public firms may benefit from private firms’ novel innovation by reducing their own cost of innovation (“Value Hypothesis”). On the other hand, such innovation may negatively affect public firms by rendering older industries or companies obsolete (“Schumpeterian Hypothesis”). The smartphone revolution illustrates how startups can lower innovation costs for some public firms while disrupting others. Android, developed by a startup in 2003, introduced a flexible, open-source mobile operating system. It significantly reduced the cost and complexity for hardware makers like Samsung, LG, and Motorola to compete in smartphones without building their own OS. As Android matured, it enabled rapid innovation and customization. Meanwhile, Blackberry and Nokia, once dominant, clung to proprietary systems and failed to adapt to touch interfaces and app ecosystems. By the time they responded, Android had become the global standard, and both lost relevance - demonstrating how startup-led innovation can fuel growth for adaptable firms while displacing those slow to evolve.

To test which effect dominates on average, we construct a novel measure of technology spillover from private firms to public firms. Following the literature on technology spillovers, we measure the overlap of patenting activity across similar technology fields for both public and private firms. We then weight technological overlap by the number of inventors at each private firm and aggregate this at the public firm-year level. We construct this measure separately for two distinct types of young, private firms: entrepreneurial firms, defined as those three years old or younger, and venture-backed firms prior to exit. We validate this measure by showing that it is associated with increased patent citations, patent similarity, and active information acquisition by public firms about private firms.

We find that an increase in spillover from young firms increases public firms’ innovation output, proxied by patents produced and the number of citations received. However, unlike spillovers from other public firms, spillovers from private firms are associated with a shift toward more novel and breakthrough technologies. This distinction highlights a unique contribution of young, private firms: not only do they lower the cost of innovation, but they also shift the innovation toward more disruptive and high-impact technologies.

Omitted variables, particularly transitory shocks, may confound our analysis by simultaneously affecting spillovers and innovation output. Non-compete laws, which are governed at the state level, have shown to negatively impact labor mobility, entrepreneurial innovation and entrepreneurial entry. Young firms, depending on where they are headquartered, are differentially exposed to these laws. For example, those located in states with strong non-compete enforcement will have fewer inventors available to them, limiting their innovation - and, in turn, reducing the disclosures from which public firms can learn. Therefore, for a given public firm, we measure its private firm peers' exposure to non-compete laws based on their headquarters' locations and establish a causal link between private firm spillovers and public firm innovation output. We are careful to exclude public and private firm-pairs located in the same state to mitigate the concern that the public firm will be subject to the same non-compete law. 

If private firms’ innovation affects public firm innovation, how do these knowledge transfers occur? A well-established literature identifies labor mobility as a key channel for knowledge transfer. Consistent with this, we find that greater spillovers with young firms are associated with an increase in both the number and proportion of newly hired inventors from young firms by public firms. Similarly, we find that larger young-firm spillovers are associated with more acquisitions of VC-backed firms, indicating public firms not only directly hire young firm inventors, but “acqui-hire” them as well.

In contrast to acquisitions, corporate venture capital (CVC) investments usually occur when public firms have no overlap in knowledge base with young firms, aiming to learn more about new technologies to enhance their innovation efforts. Consequently, we find no significant relationship between private firm spillovers and CVC investments. 

Together, these findings shed new light on an understudied externality shaping public firm innovation:  technology spillovers from young, private firms. While private firms are often assumed to offer limited learning opportunities to public companies, we find that their innovations meaningfully reduce the cost of innovation for public firms and shift their output towards more novel and high-impact technologies. These benefits are primarily realized through inventor hiring and acquisitions. 

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By Melissa Crumling (Drexel University) and Tanja Kirmse (Miami University)

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