Safeguarding proprietary information in the supply chain and relationship-specific investments

Abstract

We examine whether the risk of losing proprietary information through the supply chain affects relationship-specific investment (RSI) decisions by supply chain partners. Using state courts' staggered adoption of the Inevitable Disclosure Doctrine (IDD) as a shock to the firm's ability to protect proprietary 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 using cross-citation measures of RSI and alternative estimations that mitigate potential biases arising from the staggered difference-in-difference approach. Our findings suggest that proprietary information protection enables firms to reduce contracting frictions arising in supply chain relations.