University of Sydney: Trade secret protections benefit small firms, consumers, says research

The debate over whether proprietary knowledge protection helps or hinders market competition has received a resounding vote in favour of the former, in new research that studied the performance of over 10,000 US-based companies.

The study found states that adopted laws to protect proprietary knowledge saw increased sales performance and more companies enter the stock market.

Proprietary knowledge – perhaps better known as a ‘trade secret’ or ‘secret method’ – covers any information a company wishes to keep from its rivals, ranging from production methods to salaries and marketing strategies.

Those opposed to rules to protect proprietary knowledge argue they hinder skilled recruitment and prevent ‘knowledge spill-over’ from larger firms to new rivals, harming product development and leading to increased market dominance of more established companies.

But new research published in the Journal of Financial and Quantitative Analysis has found that enhancing proprietary knowledge protection helps small, young and “shallow-pocket” firms maintain their competitive advantage, grow their market share and develop better new products – ultimately benefiting consumers.

Inevitable Disclosure Doctrine put theory to the test
Study co-author Associate Professor Buhui Qiu from the University of Sydney Business School explained that the staggered adoption and rejection of the Inevitable Disclosure Doctrine (IDD) in different US states over several decades provided a ‘natural experiment’ to test the impact of laws designed to protect proprietary knowledge.

“The mobility of employees is one main way proprietary knowledge is leaked. The IDD is specifically designed to stop this by preventing a former employee from working for a rival firm if doing so will inevitably disclose the former employer’s proprietary knowledge or trade secrets,” said Associate Professor Qiu.
“The adoption of this legal doctrine by a state court thus significantly enhances the ability of firms located in that state to protect their production-relevant proprietary knowledge.”
The study used a broad sample of 10,198 public US firms that covered almost all sectors (except finance and utility) across all states in the US, including multiple states where IDD was adopted and later rejected by the state court.

It found the adoption of IDD resulted in a 2.3 percent increase per year in industry-adjusted sales growth compared to control firms. The impact was six times as large for young firms as for old firms, and twice as significant for small firms compared to large firms.

Furthermore, in states that adopted and later rejected IDD, there was almost always a statistically significant decline in product market performance following rejection.
Comparing results between neighbouring states also allowed researchers to factor in variables such as macroeconomic and political conditions.

Non-compete clause: know what you’re signing
Associate Professor Qiu said the findings had global economic implications.

“Although our empirical investigation is based on US firms, our research findings based on large-sample evidence could be applied to other developed economies such as Australia due to their very similar institutional environments,” said Associate Professor Qiu.
“This study demonstrates that legal decisions on intellectual property protection have far-reaching implications on firms’ abilities to compete and the competition strategies they employ.”
The Inevitable Disclosure Doctrine has been referred to in Australian law; for example in May 2021 when Justice Beach of the Federal Court ruled in favour of an established lender enforcing a 12-month non-compete clause to prevent a senior employee moving to a new competitor.
Despite working against a new firm in this instance, Associate Professor Qiu said this kind of protection is particularly important for new entrants, “and can therefore improve the competitive environment of the knowledge-based economy and promote economic growth and consumer welfare”.
“Proprietary knowledge protection through the Inevitable Disclosure Doctrine can be used in conjunction with other policies of protecting intangible assets, such as non-compete clauses and patent, trademark and copyright protections, to ease the difficulty of financing knowledge assets.”