FormalPara Definition

Trade secret consists of any proprietary knowledge or information which is not publicly known or reasonably ascertainable but which is valuable to the secret holder.

The subject matter of trade secret encompasses advertising strategies, client lists, consumer profiles, designs, formulas, manufacturing processes and sales methods. Trade secrets are consistently regarded by most European and American technology managers as more important than patents in the appropriation of returns from technical innovation (Arundel and Kabla 1998; Cohen et al. 2000; Arundel 2001; Png 2011). Although the precise language and interpretation varies across legal systems, there are three general standards that are common to the definition of trade secret:

  1. (a)

    The information must be kept confidential, that is, is not generally known, or readily accessible, to the public.

  2. (b)

    The information must confer some economic value on its holder, and the value must be derived specifically from its not being generally known (i.e., not just from the value of the information itself).

  3. (c)

    The owner must make reasonable efforts to maintain the confidentiality of the secret in question.

Owners of a trade secret can take a variety of (civil and commercial) precautionary measures to preserve confidentiality, for example, non-disclosure agreements within employee contracts and non-compete clauses in vendor supply or licence arrangements. Violators of these agreements may be liable for financial penalties.

The protection of trade secrets from being misappropriated is an important legal aspect in many societies to safeguard overall economic vitality. Misappropriators of trade secrets can incur legal liability, subject to the holder’s obligation to take reasonable steps to maintain its secrecy. In the United States, trade secrets are under state jurisdiction, and were historically protected by common law (Png 2011). About 46 states have adopted the Uniform Trade Secrets Act (UTSA) as the basis for trade secret law. Another relevant legislation is the Economic Espionage Act of 1996, under which the theft or misappropriation of trade secrets constitutes a federal crime.

The advantages conferred by the legal protection of trade secrets over that of patents include exemption from any procedural formalities. Consequently, trade secret protection involves no registration costs, can have immediate effect, and does not lead to the disclosure of the confidential information. This effectively permits perpetual monopoly status and unlimited protection as long as appropriate efforts are made to maintain secrecy and the secret has not been made known to the public, whereas patents normally specify a limited period of protection (usually 20 years). Moreover, trade secret protection has a broader scope and lower qualification criteria, covering works in progress and extending beyond technical innovations to business ideas, marketing concepts, customer lists and so on.

The downside of trade secret is that the protection is generally weaker than that for patents. It does not provide a minimum protection period, nor does it provide protection against accidental disclosure, independent discovery or reverse engineering. In addition, the enforceability of trade secret protection is relatively low and the administration costs are likely high. The costs of confidentiality maintenance for the holder of a trade secret can also be potentially high. Moreover, there may be a risk of legitimate patenting of the same invention by a third party.

Trade secret laws usually supplement patent laws (Friedman et al. 1991). The holder of a patentable invention can choose whether to resort to trade secret in order to appropriate the returns from its invention, by gauging the overall advantages and disadvantages relative to those of patenting. For example, trade secrecy can be chosen, when the estimated likelihood is relatively low that the information can be legitimately acquired by a third party within the period of patent protection, or when the value of the invention is believed to be too small relative to the registration cost of patenting. Nevertheless, trade secrecy can complement patent protection, especially during the period prior to the formal grant of the patent, or for ongoing/additional innovation that is not fully covered or disclosed within patent registration.

There is a substantial academic literature on the benefits a firm can derive from sharing confidential demand or cost information with competitors and thus from influencing their behaviours to its own advantage (e.g., Novshek and Sonnenschein 1982; Gal-Or 1986; Shapiro 1986; Villas-Boas 1994). Vives (1984) and Raith (1996) show that the equilibrium incentives of competing firms to share confidential information are affected by the nature of the product (substitutes or complements) and the nature of competition (Cournot or Bertrand). Shepard (1996) points out that a firm can benefit from licensing its proprietary technology to competitors, because the increasing competition can allow the firms to make a credible quality commitment and thus enhance industry demand.

There is another stream of academic studies in operation management and in marketing that examine how information-sharing can improve the efficiency of a supply chain by reducing production, logistical or inventory-related costs (e.g., Cachon and Fisher 2000; Kulp et al. 2004; Iyer et al. 2007; He et al. 2008). This literature highlights the strategic incentives to exchange confidential information in order to mitigate distorted behaviours from other channel partners (i.e., vendors, retailers). Recent developments in this literature investigate how these strategic incentives are influenced by the channel structure (e.g., Li 2002; Gal-Or et al. 2008), and by whether the sharing mechanism is mandatory or voluntary (Guo 2009; Guo and Iyer 2010).

The economics of trade secret law is primarily concerned about the legal arrangements under which the private sector’s incentives for ex ante investments on innovation and for ex post sharing are compatible with the socially optimal outcome. In comparison to patent law, although the protection of trade secret may lead to excessive duplication of ex post inventive efforts, it may discourage too many ex ante investments due to its relatively weaker protection (Friedman et al. 1991). Another question is why certain conduct to unmask competitors’ trade secrets (e.g., accidental disclosure, independent discovery and reverse engineering) are permitted while others (e.g., industrial espionage, breach of agreement, bribery) are prohibited. Relative to the unlawful conducts, the lawful ones are more costly to prevent, involve greater social benefits of information-sharing, and/or can induce less defensive (and socially suboptimal) efforts from the trade secret’s owners.

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