by Dennis Crouch
Anecdotal whispers in my ears suggest that many companies are now looking more toward trade-secrecy as well as confidentiality and non-compete protections in reaction to both (1) shifts in patent law that have incrementally weakened the power of patent rights and also (2) to the potential creation of a national trade secret cause of action under the new Republican congress.
Disclosure vs Secrecy: A major public policy difference between patents and trade secrets is that patents require full public disclosure prior to obtaining rights while trade-secrecy requires just the opposite – affirmative steps to keep the information from the public.
Most discussions of the differences focuses on the public value of disclosure on a macro-economic scale. However, an interesting new article by a group of economists at Georgia Tech (N. Dass) and Rutgers (V. Nanda and S. Xiao) look instead to the micro-economic impact — asking whether a relative shift in legal rights toward either patents or trade secrecy impacts the innovative companies. To be clear, these economists are not experts on intellectual property law, but instead are experts on stock market liquidity and ways that information impacts that liquidity.
Information Asymmetry: Market transactions generally have some amount of information asymmetry where the seller may know more about the product than the buyer or perhaps one buyer knows more than other buyers. Major asymmetry tends to gum-up market transactions because buyers encounter more risk and may need to do more due-diligence investigation. This is a recognized problem and, as such, many of the rules associated with publicly traded companies serve as attempts to avoid the information asymmetry. Prior studies have found that information asymmetry tends to decrease stock liquidity for publicly held corporations.
Public Information and IP Rights: Patents provide investors with direct information regarding the rights held by various companies. On the other hand, companies generally cannot disclose their trade-secrets to investors (except for closely-held private companies). From these origins, the Dass makes the following hypothesis:
We expect the choice between secrecy and patenting to be affected by the degree of relative protection provided and to have distinct implications in terms of stock liquidity and equity financing. Our hypothesis is that stronger secrecy protection will encourage firms to adopt more secrecy, therefore increases information asymmetry and reduces stock liquidity. By contrast, better patent protection is hypothesized to cause firms to disclose more information by patenting their inventions, resulting in higher stock liquidity.
To test this hypothesis, the authors conducted a retrospective study that looked to historic changes in patent law (TRIPS implementation) and trade secret law (states strengthening law) and considered market reaction to those changes:
We find that exogenous, staggered passage of state-level statutes that strengthened trade-secret protection increase opaqueness, reduce stock liquidity and worsen the market’s reaction to announcement of seasoned equity offerings (SEOs). By contrast, implementation of [TRIPS], that strengthened patent protection, enhanced transparency and stock liquidity of patenting firms and reduced the stock market reaction to SEOs.*
The basic result here is that a relatively stronger patent regime provides companies with an incentive to obtain patents which, in turn, makes it easier for those companies – especially smaller companies – to raise money in the capital market. Now, although the study was primarily focused on market liquidity, the authors also found that increasing either IP-schema (patents or TS) has the impact of increasing R&D activity.
In recent history (up until the past few years), both patent and trade secret rights have only been on the rise and so the authors were unable to study if the market phenomena also work in reverse. Lucky (at least for these academics), Congress and the Supreme Court have offered a natural experiment for a follow-on investigation in a few years.
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* Here, although not entirely clear from the study, the authors apparently use “transparancy” and “opaqueness” to actually mean that the company received respectively more or less patents following the legal change.