Does Knowledge Protection Benefit Shareholders? Evidence from Stock Market Reaction and Firm Investment in Knowledge Assets

Abstract

This article studies whether knowledge protection affects shareholder value and firms’ investment in knowledge assets using the staggered adoptions and rejections of the inevitable disclosure doctrine (IDD) by U.S. state courts as exogenous changes in the level of knowledge protection. We find positive (negative) abnormal stock returns around the IDD adoption (rejection) day for firms headquartered in the state, and we uncover a positive IDD treatment effect on firms’ investment in knowledge assets. Moreover, the effects on stock returns and knowledge assets investment are stronger in more knowledge-oriented industries and firms. Finally, enhancing knowledge protection does not discourage local entrepreneurial activity.

The effect of trade secrets protection on disclosure of forward‐looking financial information

“…Finally, our study also contributes to recent studies of the effect of trade secret protection laws on employee mobility and knowledge spillover (Png, , ), patenting (e.g., Dass, Nanda, & Xiao, ; Glaeser, ; Png, ), firms’ capital structure (Klasa et al., ), cost structure (Gao & Wang, ), investment in knowledge assets (e.g., Qiu & Wang, ), corporate social responsibilities (Flammer & Kacperczyk, ), and firm value (Castellaneta et al., ; Klasa et al., ; Qiu & Wang, ). Our evidence shows that strengthening trade secret protection laws could lead to more disclosure of forward‐looking financial information.…”

“…Overall, the evidence suggests that the IDD may have a second order effect on management incentives and management forecasts. This could be because the direct effect of IDD on firms’ competitive position, investment in human capital (Qiu & Wang, ), and compensation contracts (Garmaise, ) alters or interacts with CEOs’ incentives, making it difficult to detect the effect of IDD on management forecasts via the CEO incentive channel.…”

“…Trade secret protection laws can also affect firms’ innovation activities. Liu () shows that in technology companies the adoption of the IDD leads to greater investment in innovation; Qiu and Wang () document that after IDD adoption firms headquartered in the adoption states invest more in knowledge assets. Gao and Wang () show that firms’ cost elasticity increases after the adoption of the IDD, suggesting that the IDD reduces reliance on fixed assets and increases barriers to entry.…”

“…() show that trade secret protection law UTSA increases the value of a merger and acquisition target when the target is in an industry with a high number of knowledge workers. Qiu and Wang () show that adoption (rejection) of the IDD is associated with positive (negative) abnormal stock market returns. Klasa et al.…”

“…As adoption of IDD requires a delicate balance between protecting the interest of employees and that of employers (Friedman, Landes, & Posner, ), state courts in the US exhibit different attitudes in acceptance or rejection of the doctrine (Kahnke, Bundy, & Liebman, ). Recent studies show that the adoption of the IDD significantly reduces employee mobility and knowledge spillovers (Png & Samila, ), decreases the risk of a firm losing its competitive position in its product market (e.g., Klasa, Ortiz‐Molina, Serfling, & Srinivasan, ; Png, ), increases barriers to entry (Gao & Wang, ), and enhances firm value (e.g., Castellaneta, Conti, & Kacperczyk, ; Klasa et al., ; Qiu & Wang, ).…”