Buying Loyalty: Theory and Evidence from Physicians

Abstract

Skilled-services firms often lack full control over their key assets -- the relationships between their workers and clients. This problem can lead to investment holdups that distort labor market equilibria. We study how non-compete agreements (NCAs), which prohibit a worker from leaving a firm and then competing against it, can overcome this control problem. We show theoretically that NCAs reduce investment holdups and increase productive efficiency. These direct effects lead to higher worker earnings, larger returns to tenure, and longer job spells. However, NCAs also reduce the ex post bargaining power of workers, which can alter the structure of contracts. Using new survey data from physicians, we find that physicians with NCAs have contracts with output incentives that are more than twice as strong, they are over 40% more productive, earn 14% higher wages, and have within-job earnings growth that is 21 percentage points higher, despite being of the same average quality as physicians without NCAs. Decomposing earnings growth, we find that NCAs increase returns to both tenure and experience, suggesting that they promote general as well as firm-specific human capital investment. All of the effects increase in magnitude with the enforceability of state NCA laws.