DO NON-COMPETITION AGREEMENTS LEAD FIRMS TO PURSUE PATH-BREAKING INVENTIONS?

Abstract

Non-competition agreements are contracts signed by employees and firms that prohibit employees from joining or forming a rival company after splitting from the firm. Stricter enforcement of such contracts may induce firms to undertake riskier R&D projects, leading to technological breakthroughs or dead ends. Specifically, non-competition agreements reduce the risk that the firm loses the fruits of inventive activity by its employees, such that when the enforcement of non-compete covenants is stricter, firms grant corporate inventors more freedom to explore risky but high-potential research paths. This study uses data about U.S. patent applications between 1990 and 2000 to identify the impact of non-competition agreements and considers both cross-state and longitudinal variation in the enforcement of non-compete clauses. The empirical findings are mainly consistent with theory and show that in states with stricter enforcement, companies are more likely to undertake risky and potentially path-breaking R&D projects than in states that do not enforce non-compete agreements as strictly.