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Intellectual Property Protection and Financial Markets: Patenting vs. Secrecy
Abstract
Firms can protect intellectual property (IP) either by keeping inventions secret or by patenting the IP, which entails detailed information disclosure. Our hypothesis is that the firm's choice between secrecy and patenting is influenced by the relative protection provided, which then has distinct implications for stock liquidity and equity financing. Stronger IP-protection through trade secrets (patents) is expected to encourage firms to rely more (less) on secrecy, thus increasing (reducing) information asymmetry and stock illiquidity. Our empirical findings are supportive: exogenous, staggered passage of state-level statutes that strengthen trade-secret protection result in: fewer patent applications, increased opaqueness, greater stock illiquidity, and worse announcement reaction to seasoned equity offerings (SEOs). By contrast, implementation of the international Agreement on Trade-Related Aspects of Intellectual Property Rights (a.k.a. TRIPS), that strengthened patent-protection, is followed by an increase in patenting, enhanced transparency, greater stock liquidity, and a less negative stock-market reaction to SEOs.
... The present study focuses on choice of appropriability mechanism, conditional on the success of R&D. In independent work focusing on the effect of trade secrets law on equity finance and disclosure respectively, Dass et al. (2014) and Glaeser et al. (2017) find that the UTSA was associated with less patenting. Contigiani et al. (2016), Liu (2016), and Huang and Png (2017) also investigate the effect of trade secrets law on patenting. ...
... The checks include constructing the company-level measure of the increase in the legal protection of trade secrets due to the UTSA in three different ways: (i) simple average of the UTSA indexes of the states in which the company performs R&D; (ii) average of the UTSA indexes weighted by the numbers of inventors as stated in patent applications assigned to the company; and (iii) simply as the UTSA index in the state of the company headquarters according to Compustat. The latter check is useful in comparing my findings with independent work by Dass et al. (2014) and Glaeser et al. (2017), who associate the UTSA with the state of the company headquarters. The estimated marginal effect is −60.9% (p 0.149) is larger than the preferred estimate that accounts for the geographical distribution of R&D, but is not precise. ...
... In independent work focusing on the effect of trade secrets protection on equity financing and disclosure, Dass et al. (2014) and Glaeser et al. (2017) also find that the UTSA is associated with less patenting among U.S. publicly-listed companies. However, their analyses are purely empirical and they do not provide any theoretical interpretation, and cannot account for heterogeneity in the relation between the UTSA and patenting. ...
As they change jobs, engineers and scientists carry knowledge from one employer to another. Spillovers of knowledge, and so, innovation and economic growth, depend on institutions that influence professional mobility. Here, I investigate the impact of U.S. state-level trade secrets law on the movement of engineers and scientists among employers within states. I find that mobility was negatively associated with the legal protection of trade secrets, as characterized by a new index of trade secrets law. Specifically, an increase in the index by 0.417, representing the effect of California’s enactment of the Uniform Trade Secrets Act, was associated with 0.4% lower mobility of postgraduate-qualified engineers and scientists. The negative association between the strength of trade secrets protection and the mobility of postgraduate-qualified engineers and scientists was weaker to the extent that the state enforced covenants not to compete. My results have implications for the degree of knowledge spillovers between established organizations as well as the rate of entrepreneurial start-ups, and ultimately, the overall economy-wide rate of innovation and economic growth.
... However, informal IP protection cannot always be effective. Scholars noticed the information asymmetries that autodidact employees may self-teach some information in their work environment, which may inflame trade secret misappropriations and involuntary information disclosure (e.g., Franco and Mitchell 2008;Schwartz 2013;Dass, Nanda, and Xiao 2014). There is also another type of asymmetric information originated and held only by employees to be deadweight losses to companies (Wang 2020). ...
... Second, patents are more expensive than trade secrets in application, maintenance, and litigation (Almeling 2012;Scotchmer and Green 1990;Lippoldt and Schultz 2014;Yang 2019). Thus, some scholars suggested that small firms should prefer trade secrets to patents, especially when a patent cannot generate enough revenue or investment to offset the costs of patent application and maintenance (e.g., Levine and Sichelman 2018;Arundel 2001;Lemley 2008;Dass, Nanda, and Xiao 2014;Lippoldt and Schultz 2014). Third, the length of patent protection is limited to 20 years, but trade secrets can be perpetual (Feldman 1994). ...
... Accordingly, there is a risk that the employees who can access unpublished information divulge it to outsiders as knowledge spillovers that spur reverse-engineering or independent innovation (Schmidt 2011). Dass, Nanda, and Xiao (2014) believe that companies consider this risk when training employees. ...
Employee mobility and betrayal increase the risks of disclosing unpublished technical information. This study builds a theoretical foundation for the loss of unpublished technical information regarding human capital. It analyzes the inefficiency of informal intellectual property (“IP”) strategies, which include non-disclosure agreements (“NDAs”), covenants not to compete (“CNCs”), and trade secrets, from the maximum probable loss approach. It bridges the legal literature and the economics literature by emphasizing and explaining the information asymmetries in employment relationships regarding the informal IP strategies. NDAs need to be supplemented by CNCs or trade secret law. Enforceable CNCs and trade secrets have a reward function, but trade secrets are more efficient in informal IP management and innovation. Beyond the legal risks imposed by informal IP, companies should actively improve employee loyalty and their security culture through employee management.
... Research indicates that the quality of regulations on the protection of intellectual property rights affects the propensity to patent to a large extent. More efficient protection, as well as the introduction of international agreements on cooperation in the sphere of intellectual property (for example the Trade-Related Aspects of Intellectual Property Rights -TRIPS) means more patent applications are filed, whereas less efficient systems promote treating inventions as 'company secrets' (Dass et al., 2015). ...
Patenting activity is broadly analysed in the literature at the micro, mezzo, and macroeconomic levels. Yet, not much attention regarding this issue is devoted to European countries in transition. The main aim of the study is a quantitative analysis of all patent applications filed with and grants issued by the Polish Patent Office throughout the period of 1990– 2018 at the aggregate and regional level. We investigate trends and factors determining the patenting activity in Poland – the country at an advanced level of the economic and social transition. The empirical analysis leads to several findings. First of all, we identify changes in the field of patenting related to Poland’s accession to the EU in 2004, which resulted in the increase of residents’ patenting activity and decrease of that of non-residents (in terms of the number of filed applications and granted patents at a national and regional level). This holds for absolute numbers as well as for a per capita perspective. Additionally, we demonstrate that the increase in R&D expenditure is not followed by a proportional increase in patenting, as the patent-to- R&D ratio is systematically shrinking. Finally, the study compares trends in patenting activity in Poland with those in different groups of countries, proving that the dynamic of change in Poland is much slower than could be expected.
... Second, trade secrets and patents may work as substitutes (Png 2017b). Since the adoption of the IDD may weaken the need for the external protection of patents, firms may wish to avoid the disclosure and other costs of patent applications (e.g., Dass et al. 2018). To mitigate these limitations, in column (3) we examine the retention of all employees, regardless of whether they file patents or not. ...
We present evidence that the desire to gain human capital is an important motive for corporate acquisitions. Our tests exploit the staggered recognition of the Inevitable Disclosure Doctrine (IDD) by U.S. state courts, which prevents employees with trade secret knowledge from working for other firms. We find a significant increase in the likelihood of being acquired for firms headquartered in states that recognize such a doctrine relative to firms headquartered in states that do not. Our result is stronger for firms with greater human capital and for firms whose employees have better ex ante employment mobility. We show that the IDD is positively associated with the retention of target firms’ key technicians, employees, and top executives after an acquisition. We also show that the IDD is positively associated with synergy creation, acquirers’ announcement returns, and acquirers’ long-run stock and operating performance. Overall, our result indicates that corporate acquisitions can be used as a means for firms to overcome labor market frictions and gain access to valuable human capital.
This paper was accepted by David Simchi-Levi, finance.
... Longer patent life implies a higher propensity to patent for first inventors, while prior user rights would foster innovation in highly competitive markets. Dass, Nanda and Steven (2015) empirically analyzed the role of the relative protection provided by patent and trade secrets law in the US. They found that the strengthening of trade secret law by US states led to fewer patent applications, increased opaqueness, greater stock illiquidity, and worse announcement reaction to seasoned equity offerings (SEOs). ...
This paper analyzes the use and effectiveness of patents and trade secrets designed to protect innovation. While previous studies have usually considered patents and trade secrets as substitutes for one another, we investigate to what extent and in what situations the two protection methods are used jointly. We identify protection strategies for single innovation firms and hence overcome the assignment problem of existing empirical studies, that is, whether firms using both protection methods do so for the same innovation or for different innovations. Employing firm panel data from Germany, we find fairly few differences between the determinants for choosing secrecy and patenting. Single innovators that combine both strategies, 39% of the group, tend to aim at a higher level of innovation and act in a more uncertain technological environment. Firms combining both protection methods yield significantly higher sales with new-to-market innovations, providing some evidence for a complementarity of the two protection methods.
The Leahy-Smith America Invents Act of 2011 (AIA) fundamentally changed the U.S. public patent system. This study examines whether and how the enactment of the AIA affects innovation-intensive firms’ narrative R&D disclosure. Adopting a difference-in-difference design, we find that the enactment of the AIA is associated with a greater decline in narrative R&D disclosure of innovation-intensive firms relative to non-innovation-intensive firms. This effect is more pronounced for firms that are more concerned about the proprietary costs of disclosure and firms with fewer financial constraints. Moreover, we show that the enactment of the AIA dampens analysts’ information environment and aggravates information asymmetry. Overall, our results suggest that the AIA has a negative impact on corporate disclosure and information asymmetry. The documented unintended effect of the AIA could potentially work against lawmakers’ efforts to bolster innovation and the dissemination of knowledge.
Using the recognition of the Inevitable Disclosure Doctrine (IDD) by U.S. state courts as an exogenous shock to the risk of losing trade secrets, this study examines the effects of trade secrets on disclosure of forward‐looking financial information. We find that management earnings forecast frequency and forecast horizon increases after the U.S. state where a firm is headquartered starts to recognize IDD. We also find that the effect of IDD recognition on management forecasts is more pronounced for firms that have larger market shares, higher product market competition, more intensive R&D, shorter distance to their industry rivals, and more employees who possess knowledge of the firms’ trade secrets. This article is protected by copyright. All rights reserved
I examine the effects of proprietary information on corporate transparency and voluntary disclosure. To do so, I develop and validate two measures of firms’ reliance on trade secrecy: one based on 10-K disclosures and one based on subsequent litigation outcomes. I complement these measures by using the staggered passage of the Uniform Trade Secrets Act as a shock to trade secrecy. I find that firms that begin to rely more heavily on trade secrecy substitute increased voluntary disclosure of nonproprietary information for decreased disclosure of proprietary information. The total effect of trade secrecy is a decrease in corporate transparency.
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