Trade Secret Laws and Investment: Evidence from Venture Capital

47 Pages Posted: 30 Oct 2017 Last revised: 25 Nov 2018

See all articles by Lifeng Gu

Lifeng Gu

The University of Hong Kong

Ruidi Huang

University of Illinois at Urbana-Champaign - Department of Finance

Yifei Mao

Cornell University - SC Johnson College of Business - Finance Department

Xuan Tian

Tsinghua University - PBC School of Finance

Date Written: November 2018

Abstract

We examine the effect of trade secret protections on venture capital (VC) investment. Exploiting variation generated by staggered adoption of the Inevitable Disclosure Doctrine (IDD) that protects trade secret by restricting labor mobility, we find that IDD reduces VC investment likelihood. This effect is more pronounced when human capital is more important to the startups, VC investment is more uncertain, and VCs’ monitoring cost is higher. Further analyses show that muted employees’ incentives to produce innovation output is a plausible underlying mechanism. To mitigate this adverse effect, VCs stage finance startups and syndicate with other VC investors. VCs, however, still experience a decrease in successful exit rates because they cannot fully adjust their portfolio firms across states. Our paper sheds new light on the real effects of labor market frictions via the lens of VC markets.

Keywords: Venture capital, inevitable disclosure doctrine, human capital risk

JEL Classification: G24, G23, G34

Suggested Citation

Gu, Lifeng and Huang, Ruidi and Mao, Yifei and Tian, Xuan, Trade Secret Laws and Investment: Evidence from Venture Capital (November 2018). Available at SSRN: https://ssrn.com/abstract=3060837 or http://dx.doi.org/10.2139/ssrn.3060837

Lifeng Gu

The University of Hong Kong ( email )

Hong Kong
+852 3917-1033 (Phone)

HOME PAGE: http://https://sites.google.com/site/uiuclifenggu/

Ruidi Huang

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

HOME PAGE: http://sites.google.com/site/huangruidi/

Yifei Mao (Contact Author)

Cornell University - SC Johnson College of Business - Finance Department ( email )

Ithaca, NY 14850
United States

Xuan Tian

Tsinghua University - PBC School of Finance ( email )

No. 43, Chengfu Road
Haidian District
Beijing 100083
China
+86-10-62794103 (Phone)

HOME PAGE: http://xuantian.info/

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