Trade Secret Laws and Investment: Evidence from Venture Capital
47 Pages Posted: 30 Oct 2017 Last revised: 25 Nov 2018
Date Written: November 2018
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: Suggested Citation