Money secrets: How does trade secret legal protection affect firm market value? Evidence from the uniform trade secret act

• DOI: http://doi.org/10.1002/smj.2533
• Published date: 01 April 2017
• Author: Raffaele Conti,Francesco Castellaneta,Aleksandra Kacperczyk
• Date: 01 April 2017

Strategic Management Journal

Strat. Mgmt. J.,38: 834–853 (2017)

Published online EarlyView 19 July 2016 in WileyOnline Library (wileyonlinelibrary.com) DOI: 10.1002/smj.2533

Received 15 May 2015;Final revision received30 March 2016

MONEY SECRETS: HOW DOES TRADE SECRET

LEGAL PROTECTION AFFECT FIRM MARKET VALUE?

EVIDENCE FROM THE UNIFORM TRADE SECRET ACT

FRANCESCO CASTELLANETA,1RAFFAELE CONTI,1and ALEKSANDRA

KACPERCZYK2*

1Catolica Lisbon School of Business and Economics, Lisbon, Portugal

2MIT Sloan School of Management, Cambridge, Massachusetts, U.S.A.

Research summary: Weinvestigate the impact of trade secret legalprotection on rm market value

in the context of acquisitions. On one hand, market value may increase because tradesecret assets

become better protected fromrivals. On the other hand, market value may decrease because trade

secret protection reduces information about the target and its competitors available to potential

buyers, increasing uncertainty about its value. Buyers will discount their offers in expectation of

being compensated for riskier deals. Using a sample of private equity investments in the United

States, we nd that trade secret protection has a positive effectin industries with high mobility of

knowledge workers, but a negative effect in industries with (1) high resource– value uncertainty

and (2) high poor-investment risk.

Managerial summary: We argue that an increase in trade secret legal protection might not

unequivocally benet rm owners when selling their business. A stronger trade secret protection

increases the market value of rms in industries with high workers’ mobility, but it decreases

the market value of rms in industries with uncertain resource value and/or high risk of

poor-acquisition investments. Based on the contingent effect of trade secretprotection, companies

may want to adjust their strategicdecisions, including where to locate or relocate, based in part on

whether they will derive benets or suffer losses when trade secrets are better protected. Finally,

our study should help policymakers understand more fully the economic impact of government

policies associated with trade secrets. Copyright © 2016 John Wiley & Sons, Ltd.

INTRODUCTION

The strategy literature has long argued that valuable

resources are key for rm sustainable competi-

tive advantage (e.g., Barney, 1991; Mahoney

and Pandian, 1992; Rumelt, 1984). In partic-

ular, as world economies become increasingly

knowledge-intensive, outperforming rivals depends

more and more on rms developing proprietary

Keywords: trade secrecy; market value; legal environment;

buyout; natural experiment

*Correspondence to: Aleksandra (Olenka) Kacperczyk, Asso-

ciate Professor of Technological Innovation, Entrepreneurship,

and Strategic Management MIT Sloan School of Manage-

ment 100 Main St., E62-484; Cambridge, MA 02142. E-mail:

olenka@mit.edu

Copyright © 2016 John Wiley & Sons, Ltd.

knowledge (Grant, 1996; Kogut and Zander,

1992). Yet, the resulting competitive advantage

is hardly sustainable if rms fail to protect their

know-how by minimizing the threat of imitation by

rivals (e.g., Barney, 1991; Mahoney and Pandian,

1992; Rumelt, 1984). In this respect, the legal

appropriability regime— the extent to which the

legal system protects and enforces property rights

on intangible resources— plays a crucial role.

A large body of work on intellectual property

rights (IPRs) has established that a strong legal

IPR protection mitigates the risk of imitation

of valuable know-how, which ensures that rms

can appropriate a greater share of returns from

their intangible resources and so increases their

market value (Teece, 1986). However, the extant

accounts have mainly focused on the role of patents

How Does Trade Secret Legal Protection Affect Firm Market Value? 835

(e.g., Cockburn and Griliches, 1988; Hall, Jaffe,

and Trajtenberg, 2005), which require complete

disclosure of the underlying knowledge resource

and therefore facilitate the assessment process.

Insights gleaned from this literature might not

extend to other forms of IPR protection, such as

trade secrets, whose owners are “rewarded for

keeping information …away from the public for

an unlimited duration” (Risch, 2007: 11).

Hence, we ask: How does the legal protection

of trade secrets affect rm market value?1Trade

secrets— encompassing information on marketing

data, manufacturing know-how, chemical formulae,

and technical data— are “arguably the most impor-

tant and most heavily litigated intellectual prop-

erty rights” (Risch, 2007: 1) and are considered

the “crown jewels” of a rm’s intellectual capital

(Jorda, 2007). Yet,researchers have not linked trade

secret protection to rm value, eventhough its effect

has been documented with respect to employee

mobility (Png and Samila, 2015) and to a rm’s

incentives to innovate (Png, 2015) and to cluster

(Fosfuri and Rønde, 2004). Toll this gap, we focus

on the market for corporate control, which rep-

resents strategic factor markets where bundles of

resources are traded and the competitive advantage

of rms is monetized (e.g., Barney, 1991; Capron

and Shen, 2007; Shen and Reuer, 2005).

Against this background, we propose that trade

secret protection may affect rm market value in

two opposite ways, generating a paradox worth

exploring. On one hand, a stronger protection of a

rm’s trade secrets might limit the outward ow of

information about trade secrets to competitors and

thus lessen the risk of misappropriation and imita-

tion. Hence, the target’s value might increase. On

the other hand, trade secret protection might limit

the amount of rm-specic information available to

potential buyers and thus increase the information

asymmetries between buyers and sellers. Lack of

information increases uncertainty about the value

of the target rm, motivating buyers to discount

their offers as a compensation for pursuing a more

uncertain and riskier deal. Hence, the target’s value

might decrease. In sum, trade secret protection

may be a double-edged sword for the target rm,

creating advantageous information asymmetries

vis-à-vis its competitors as well as disadvantageous

1Wewill refer to “trade secret(s) legal protection” as “trade secret

protection” for simplicity.

information asymmetries vis-à-vis its potential

buyers.

To explore these seemingly contradictory argu-

ments, we examine the heterogeneous effects of

trade secret protection on the target’s market value.

We propose that the direction of the trade secret

protection effect might depend on the target’sindus-

try characteristic. First, an increase in trade secret

protection may have a positive effect in indus-

tries where the cross-rm mobility of knowledge

workers is higher, because a strong protection of

trade secrets constrains the amount of knowledge

that former employees may transfer to competitors

(Fosfuri and Rønde, 2004; Png and Samila, 2015).

Second, an increase in trade secret protection may

have a negative effect when the target’s industry

exhibits (1) substantial resource– value uncertainty

and hence detailed information on the target’sintan-

gible assets becomes crucial for a proper target eval-

uation (Barney, 1991) and (2) high risk of making

a poor— or “lemon”— investment, especially if a

stronger trade secret protection hampers the assess-

ment of target rms (Akerlof, 1970; Coff, 1999).

Assessing the impact of trade secret protection

on rm market value is empirically challenging

because such protection might be endogenous with

respect to rm value. For example, policymakers

might enact a law enhancing trade secret protection

to improve the state economic conditions— which

would affect local rms’ value— or the law might

result from lobbying efforts by state companies.

Hence, a research design that facilitates a clean

causal estimate is central to understanding the

impact of trade secret protection on rm market

value.

We address this empirical challenge by exploit-

ing a quasi-natural experiment provided by the

enactment of statutes based on the Uniform Trade

Secret Act (UTSA), which occurred in 46 U.S.

states between 1975 and 2008. In this period,

trade secret protection increased dramatically (Png,

2015). Important for our identication strategy,

accounts of the political economy of these reforms

suggest that their enactment was exogenous to state

economic and political characteristics, and was not

the result of any lobbying effort (Png, 2015). Specif-

ically, we test our theory on a sample of 1,890 U.S.

rms managed by 132 privateequity (PE) rms. The

PE market is an advantageous empirical setting for

testing our theory. PE rms are investors that make

prots through buyouts— buying and reselling the

control of private companies— overrelatively short

Copyright © 2016 John Wiley & Sons, Ltd. Strat. Mgmt. J.,38: 834–853 (2017)

DOI: 10.1002/smj