Research, patents, and IPO valuation under the Sarbanes‐Oxley Act of 2002

Abstract

Research and development (R&D) investments and patents influence initial public offering (IPO) valuations. After Sarbanes‐Oxley (SOX) legislation was enacted in 2002, there was a shift from a display of ‘Effort’ to ‘Results’. SOX legislation made fundamental changes to corporate accounting practices and the process of going public. We investigated how the IPO market responded to SOX legislation. Compliance with SOX was disproportionately costly for small, research‐intensive firms. Using Signaling Theory, we focused on whether the existence of patents became a valuable signal for the effectiveness of research and development expenditures (R&D). Our findings indicated decreased importance of R&D expenditures (signaling ‘effort’ to innovate). We also found increased importance of patents (intermediate ‘results’ of R&D efforts) post‐ relative to pre‐SOX. We concluded that patent activity at least partially replaced and moderated R&D in its role as a value driver of IPOs in the post‐SOX environment.