One of the primary ways that employers seek to protect trade secrets is by having employees sign noncompete contracts and nondisclosure agreements. In a recent study, we examined this issue, and found that strengthening employers’ trade-secrecy protection can backfire by dampening inventors’ productivity and hurting innovation in the long run.
A lot of innovation research suggests that innovation comes from recombining ideas from different fields, experiences and organizations. To the extent that a more employer-friendly trade-secrecy regime limits employee mobility across companies, the opportunities for idea circulation in the economy could be curtailed, thus potentially harming innovation.
Another set of theories also suggests that stronger trade-secrecy protections may diminish innovation, but for an entirely different reason. This view says that if it’s harder for employees to switch firms, they have less incentive to drive up their market value by demonstrating their productivity — and this reduced incentive could result in dampened innovation.
To find out what actually happens, we focused on a specific change in the legal environment surrounding trade-secrecy protection: the adoption of the inevitable disclosure doctrine, or IDD, in some U.S. states and not others, starting in 1994. The IDD allows a company to seek an injunction in court to prohibit a former employee from working for a competitor for a certain period of time, if they can show it would not be possible for the employee to perform her job without “inevitably disclosing” the company’s trade secrets.
We conducted an empirical analysis to understand how IDD affected the innovative productivity of inventors. In all, our sample spans 1976 to 2003 and analyzes the patenting outcomes of over 350,000 distinct inventors over that time period, for a total of over 2.5 million inventor-year observations. We found that IDD had a negative effect on innovation, and specifically on innovation quality.
We also found that after an inventor is exposed to a stronger trade-secrecy regime, that inventor systematically produces inventions that are more general-purpose (applicable to a wider spectrum of uses and industrial contexts) and thus less subject to the IDD. We interpret this to mean that if an individual can’t move to direct competitors, they may reduce effort in their current area of focus (leading to the documented innovation slowdown) and find other areas in which they can signal their innovation quality.
Overall, our study suggests that, while firms lobby for a strengthened trade-secrecy environment, this may ultimately backfire in the long run by leading to lower innovation.
(Andrea Contigiani is a doctoral candidate at the Wharton School at the University of Pennsylvania, where David H. Hsu is a professor.)
