Safeguarding Proprietary Information in the Supply Chain and Relationship Specific Investments

Abstract

We examine whether the risk of losing proprietary information through supply chain affects firms’ relationship specific investment (RSI) decisions. Using the staggered adoption of Inevitable Disclosure Doctrine (IDD) by state courts as a shock to firm’s ability to protect information, we find that customers increase RSI when their supplier is headquartered in a state that adopts IDD. The effect is more substantial for customers who face a higher risk of losing proprietary information and with suppliers that are difficult to substitute. IDD also plays a more prominent role in the absence of alternate mechanisms that reduce contracting frictions, such as shared directors, common ownership, or joint ventures. Our results are robust to alternative estimations that mitigate potential biases arising from staggered difference-in-difference approach. Collectively, our findings suggest that proprietary information protection enables firms to reduce contracting frictions arising in supply chain relations.

Keywords: Supply chain, relationship-specific investment; trade secrets; IDD adoption; contracting friction; supplier; customer; information asymmetry

JEL Classification: G34, L14