How innovating firms manage knowledge leakage: A natural experiment on the threat of worker departure

Abstract

AbstractResearch SummaryKnowledge protection strategies are crucial to innovating firms facing the risk of knowledge leakage. We examine the threat of worker departure as a key mechanism through which firms choose between patents and secrecy. We exploit a 1998 California court decision that ruled out‐of‐state noncompetes were not enforceable in California, thereby creating a loophole limiting non‐California firms in their enforcement of noncompetes against their workers. When facing a higher threat of worker departure, firms strategically increased patent filings, exchanging legal protection for public disclosure of the invention. These effects were magnified for large‐sized firms and for those in complex and fast‐growing industries. Further mechanism tests on the possession of trade secrets, inventor migration, saliency of the decision, and independent inventors support our theoretical account.Managerial SummaryInnovating firms may use patents or secrecy, among other mechanisms, to protect their knowledge from leakage. How do firms make this important strategic choice? By using a natural experiment arising from a 1998 California court decision, we show the risk of worker departure can be a key driver. The decision significantly increased the risk of workers departing non‐California firms. Our findings show that, in response to the heightened risk, affected firms increasingly relied on patents, seeking legal protection although it meant public disclosure of the invention. The effects were greater for large‐sized firms and for those in complex and fast‐growing industries. We encourage managers to consider worker mobility and, more broadly, legal environments that govern labor market conditions when formulating knowledge protection strategies.