Research

How trademarks reveal the hidden innovation of companies

A new study shows trademarks can be a better measure of innovation than patents for certain industries.

By Jane Larson

2023-03-23

Innovation is for more than just high-tech or big pharma. Many companies across different sectors are creating new products and services that consumers love — and they don't need patents to prove it.

A new study by Associate Professor of Accountancy Lucile Faurel and colleagues from Hong Kong Polytechnic University, the University of California Irvine, and the University of California Los Angeles shows how trademarks can be a better measure of innovation than patents for some industries. Other researchers studying innovation have primarily focused on patents, mainly from scientific and technological sectors heavy on research and development. But Faurel's team notes that more than half of S&P 1500 firms don't report conducting R&D activities, and nearly half don't register patents — yet these are still highly innovative companies.

Faurel and her colleagues argue that innovation should include new products and services from such companies. Financial services firms, for example, have long been devising new securities, new ways of investing, and new banking and payment methods. Beverage companies keep coming up with new recipes and containers for their products. The researchers also point to the success of new business models, such as Uber's idea of ridesharing and Netflix's twist on movie rentals.

In short, the team wants to take a broader look at "product development innovation." Surveys have shown that CEOs rank product development as highly important for their companies' innovation, growth, and performance.

"When you think of all the other firms in the economy, there are so many other types of innovation that are being done," Faurel says. "And that's where we bring in, 'Oh, how about other measures of innovation?' We're not trying to replace patents or R&D … but still, R&D and patents are pursued by high-tech firms and industries, and that's a tiny subset of the economy, versus trademarks are pursued by almost every firm in every industry in the economy."

Besides introducing product trademarks to capture product development innovation as another measure of innovation, the researchers examine if incentives such as stock options motivate CEOs to push for innovative products and if developing these products improves companies' financial performance.

"The three main questions we are after," Faurel says, "are: To what extent is product development innovation a risky, innovative activity? Can or should we incentivize top managers to pursue this activity? And is product development innovation related to future firm performance?"

Their findings break new ground in expanding the definition of innovation to include product development innovation. They show that product development innovation, captured by product trademarks, is a risky, innovative activity that improves future firm performance and is motivated using risk-taking incentives in CEO compensation.

The researchers use trademark data from the U.S. Patent and Trademark Office to measure such innovation. Companies file for trademarks — words, phrases, symbols, and designs that distinguish a source of goods — when they have new products or new models of existing products.

The team compiles a set of nearly 106,000 new trademarks filed by Standard & Poor's 1500 largest publicly traded companies between 1993 and 2011. Seeking a more accurate measure of product innovation, they delete logos, sounds, and longer slogans, all of which they deem marketing trademarks. This results in a sample of over 70,000 trademarks for new products, services, and brand names. These new product trademarks come from nearly 2,300 firms covering a range of industries, from recreational products and retail to business services and computers. High-patent sectors with 15 or more patents per year account for 52% of new trademarks, and low-patent industries with fewer than 15 patents per year — account for 48%.

The researchers match new product trademarks with information on firms' cash flow from operations, return on assets, the volatility of their stock returns, and the options portion of CEOs' compensation. The results show several significant associations.

First, new product development is risky, distinct from innovations leading to patents. Firms that emphasize developing and trademarking new products but have fewer patents tend to have more volatile stock returns — and hence more risk — than those with more patents and firms overall in the sample.

Second, firms with CEOs whose compensation includes more stock options — making the CEOs more sensitive to changes in company stock returns — are more likely to innovate with new products than firms with CEOs whose compensation is based more on salary and other safer measures. In other words, Faurel says the more that CEOs are compensated with equity, the more risks they are encouraged to take because of the potential for greater rewards. The connection between equity-based compensation and new product innovation is especially notable in industries where many firms said trademarks are essential and firms that generated above-average numbers of new product trademarks.

Third, when a company's number of new product trademarks increases, so does the company's subsequent financial performance. For each new trademark filed, cash flow from operations rises by 0.13% one year later and by 0.17% two years later; return on assets grows by 0.24% one year later and by 0.31% two years later. The percentages may look small, Faurel notes, but they are three to six times greater than the median performance of firms overall.

To further test the connection between stock option compensation and product development innovation, Faurel's team looked at the effect of a 2005 change in accounting rules, which required companies to report the value of stock option grants as an expense on their financial statements. The researchers find that companies reacted to the rules change by reducing the number of stock options offered to their executives. They also find that the firms with the most stock options pay, and therefore the ones most affected by the new rule saw the number of their new trademarks decline.

The research shows the importance of trademarks applied to low-patent and high-patent firms. If there was any surprise in the results, Faurel says, the benefits of new product innovation show up as adding value not just in low-patent firms but also in high-patent firms beyond the value of the patents themselves.

Though they study S&P 1500 firms, Faurel thinks the results would also apply to private companies and smaller firms. "I truly believe that product development innovation is valuable for a firm and would provide future revenue and profit for the firm. And I believe it would hold for firms in any industry regardless of size or public status."

Faurel is excited that more people are accepting the idea that new products don't have to be high-tech to be considered innovations. She says that more can be examined with trademarks because they reflect a very different type of innovation than patents.

The bottom line

"The main message is that product development innovation is another innovative activity pursued by all firms in the economy, which up until now, has been somewhat ignored," Faurel says. "By using it as another measure of innovation, we show that you can incentivize your top executives to pursue this type of innovation, and new product innovation leads to improvements in future firm performance."

She says the research offers these takeaways for various stakeholders:

• Boards of directors should realize that trademarks, incentive-based compensation, and a firm's future financial performance are connected. If directors want to make a firm more innovative in its products and increase its performance, they should structure top managers' contracts to include more equity-based compensation.
• CEOs should pursue new product innovation because it improves a company's performance.
• Investors can use the extent to which a company pursues product development innovation as another measure when valuing firms.
• Employees who care about their company's performance and may own company stock themselves would benefit by helping the firm innovate with new products.
• Consumers play a role, too. If firms are benefiting from innovating new products, the implication is that consumers' demand for those products is rising.

Accountancy