Screening Spinouts? How Noncompete Enforceability Affects the Creation, Growth, and Survival of New Firms

Abstract

This paper examines how the enforceability of noncompete covenants affects the creation, growth, and survival of spinouts and other new entrants. The impact of noncompete enforceability on new firms is ambiguous, since noncompetes reduce knowledge leakage but impose hiring costs. However, we posit that enforceability screens formation of within-industry spinouts (WSOs) relative to non-WSOs by dissuading founders with lower human capital. Using data on 5.5 million new firms, we find greater enforceability is associated with fewer WSOs, but relative to non-WSOs, WSOs that are created tend to start and stay larger, are founded by higher-earners, and are more likely to survive their initial years. In contrast, we find no impact on non-WSO entry and a negative effect on size and short-term survival. The online appendix is available at https://doi.org/10.1287/mnsc.2016.2614 . This paper was accepted by David Hsu, entrepreneurship and innovation.