Trade Secret Protection and Firms’ Internal Transparency

Abstract

We examine the effects of trade secret protection laws on firms’ internal transparency. By internal transparency, we refer to the extent to which information is integrated, distributed, and shared within the firm. We argue that stronger trade secret protection reduces firms’ proprietary costs of information leakage and thus incentivizes firms to increase their internal transparency. To test our prediction, we construct a novel proxy of firms’ internal transparency based on the share of sites integrated into its enterprise system and exploit the staggered adoption of trade secret protection laws via the Uniform Trade Secrets Act. We find that stronger trade secret protection increases firms’ internal transparency, and that the effect is stronger (weaker) for firms with more pronounced proprietary costs (coordination benefits). In supplemental tests, we distinguish our proxy from information security as well as general software investments and refute alternative explanations that trade secret protection laws affect internal transparency primarily via other channels such as firms’ innovation incentives, external reporting incentives, or reduced financial constraints. Taken together, our results enhance our understanding of the economic forces shaping firms’ internal information environment.