The Effect of Trade Secrets Law on Stock Price Synchronicity: Evidence from the Inevitable Disclosure Doctrine 

1 Mar 2020
Research

Accountancy

Yongtae KIM, Lixin Nancy SU, Zheng WANG, Haibin WU 

Published in The Accounting Review, March 2020 

In today’s ultra-competitive economies, outperforming rivals increasingly depends on firms’ ability to develop and maintain proprietary knowledge.  

Dr Zheng Wang, Associate Professor in the Department of Accountancy, and co-authors writing in the Accounting Review have identified the significant role of the Inevitable Disclosure Doctrine (IDD), a common law principle present in some jurisdictions in the United States that prevents an employee possessing corporate trade secrets from working for a rival company.  

“We find that after a state’s recognition of the IDD, firms located in those states experience a significant decrease in customer and product related disclosure,” says Wang. 

“At the same time, we find that firms voluntarily increase disclosure that is less likely to contain proprietary information such as the forecasts on future earnings to compensate for the decrease in the disclosure that has a proprietary nature.”  

Since the IDD has a differential effect on the disclosure of proprietary versus nonproprietary information, Wang and her co-authors use price synchronicity, a measure that captures the net amount of firm-specific information disclosed to the capital market, to assess whether, overall, firms disclose more or less firm-specific information to capital market investors after IDD recognition.  

The results show that less firm-specific information is incorporated in stock prices or disclosed to capital market investors after trade secret protection is increased by the recognition of the IDD. When firms reduce the disclosure of proprietary information, they sacrifice capital market benefits for product market benefits. They further show that the overall reduction in firm-specific information arising from IDD recognition leads to greater market share, higher cost of equity, and higher firm market value.  

“These results suggest that managers reduce the disclosure of proprietary information for greater product market benefits at the expense of capital market benefits. Also, the increase in product market benefits outweighs the decrease in capital market benefits, resulting in a net increase in firm market value,” says Wang. 

“Collectively, our evidence helps reconcile the seemingly conflicting findings in the literature that examines the relation between trade-secret protection and corporate disclosure.”  

When more firm-specific information is disclosed to the capital market and incorporated in stock prices, investors can make better financial decisions and allocate capital more efficiently. Thus, the findings suggest an unintended adverse consequence of trade secret protection: a decrease in firm-specific information production in the capital market. As such, the evidence should be relevant to investors, managers, and legal authorities for their decision-making, as well as to researchers and policymakers to evaluate the effect of trade secret laws in a more holistic way.