The Strategic Effects of Trademark Protection

By: Davidson Heath and Christopher Mace

As the U.S. economy shifts toward service- and technology-based industries, firm value is increasingly accounted for by intangible capital such as intellectual property. We examine a basic class of intellectual-property assets—trademarks—and present evidence on the effects of trademark protection on firm profits and strategy. Trademarks grant the holder a monopoly over a particular brand. The efficiency rationale for trademark protection is that it incentivizes firms to invest in product quality and development. On the other hand, stronger trademark protection inevitably insulates incumbents from competition. Whether the quality-incentive or monopoly-rent effect dominates is an empirical question with significant policy implications.

To study the causal effects of varying trademark protection, we exploit the Federal Trademark Dilution Act (FTDA) of 1995, which granted additional legal protection to “famous” trademarks until its key provision was nullified in 2003 by a U.S. Supreme Court decision. We find that the act raised treated firms’ operating return on assets by an average of 1.7 percentage points, equal to 12 percent of their average pre-FTDA profits. The passage of the act was followed by a sharp increase in trademark lawsuits under the new provision and by reduced entry and turnover in affected goods and service classes, consistent with our hypothesis that the FTDA raised the expected cost of entry into affected product markets.

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