Intellectual Property Protection and Financial Markets: Patenting vs. Secrecy

Abstract

Firms can protect intellectual property (IP) either by keeping inventions secret or by patenting the IP, which entails detailed information disclosure. Our hypothesis is that the firm's choice between secrecy and patenting is influenced by the relative protection provided, which then has distinct implications for stock liquidity and equity financing. Stronger IP-protection through trade secrets (patents) is expected to encourage firms to rely more (less) on secrecy, thus increasing (reducing) information asymmetry and stock illiquidity. Our empirical findings are supportive: exogenous, staggered passage of state-level statutes that strengthen trade-secret protection result in: fewer patent applications, increased opaqueness, greater stock illiquidity, and worse announcement reaction to seasoned equity offerings (SEOs). By contrast, implementation of the international Agreement on Trade-Related Aspects of Intellectual Property Rights (a.k.a. TRIPS), that strengthened patent-protection, is followed by an increase in patenting, enhanced transparency, greater stock liquidity, and a less negative stock-market reaction to SEOs.

Keywords: Innovation, patents, trade secrets, TRIPS, liqudity

JEL Classification: G14, G30