Legal protection of trade secrets and corporate investment efficiency

This study explores the effect of the inevitable disclosure doctrine (IDD), a form of legal protection implemented by various U.S. state courts to protect firms’ trade secrets, on corporate investment efficiency. Using a sample of 47,327 firm-year observations of U.S.-listed firms from 1993 to 2023 and a staggered difference-in-differences research design, we reveal that IDD adoption reduces corporate investment inefficiency, measured as either over- or under-investment. Further analyses show that the investment efficiency-enhancing effect of the IDD is attributable not only to its restraining effect on corporate moral hazard, that is, restricted misuse of free cash flows and enhanced alignment of managers’ interest with that of firms, but also to its effect on firms’ ability to overcome financial constraints. Cross-sectional analyses demonstrate that the effect of the IDD on reducing investment inefficiency is stronger for firms with a higher level of institutional ownership and firms facing more severe product market competition. Lastly, we find that IDD-driven investment efficiency improves future firm performance and that the adoption of the IDD results in a higher value of intangible assets. Our study enriches the emerging literature on the economic consequences of the IDD from the perspective of corporate investment, documenting the profound implications of state-level adoption of the IDD on corporate decisions.