Noncompete Enforceability Research Articles

How does worker mobility affect business adoption of a new technology? The case of machine learning

AbstractResearch SummaryWe investigate how worker mobility influences the adoption of a new technology using state‐level changes to the enforceability of noncompete agreements as an exogenous shock to worker mobility. Using data on over 153,000 establishments from 2010 and 2018, we find that changes that facilitate worker movements are associated with a significant decline in the likelihood of adoption of machine learning. Moreover, we find that the magnitude of decline depends upon the size of the establishment, the extent of predictive analytics adoption in its industry, and the number of large establishments in the same industry‐location. These results are consistent with the view that increases in outward worker mobility increase costs for adoption of a new technology that involves significant downstream investments in the early years of its diffusion.Managerial SummarySuccessful business adoption of new technologies such as machine learning requires skilled workers with experience in implementing those technologies. In the early years of technology diffusion workers in early adopting businesses typically acquire these skills through on‐the‐job learning that is paid for by the adopter. So, if such early adopters face an increased risk of those skilled workers quitting, then their incentives to adopt the technology decrease. We examine this possibility using changes in noncompete enforceability as a proxy for changes in worker mobility and find that the likelihood of adopting machine learning decreases as the risk of worker mobility increases, particularly for larger establishments, establishments in industries where adoption may be more beneficial and in locations with many large competing establishments.

Employee Mobility Constraints and Strategic Alliances

Employee mobility facilitates alliance formation due to critical information transmission. At the same time, employee mobility and alliances can be substitute means by which firms source external capabilities. We emphasize the interaction between these two relationships and ask how employee mobility constraints in labor markets affect firms' alliances. More specifically, we propose dynamic changes in alliance formation following legislative changes that constrain employee mobility (i.e., the inevitable disclosure doctrine (IDD)). In the immediate aftermath of these changes that constrain employee mobility, the substitution effect dominates, and firms form more alliances to access cabilities. In the long run, this effect is dampened due to a lack of supply of new hires that would otherwise foster technology partnerships. We further investigate factors that change the demand and supply conditions. Knowledge-intensive firms have more alliances in the aftermath and fewer alliances in the long run. Stronger noncompete enforceability shifts the timeframe so that firms do not have higher alliances even in the aftermath of IDD adoption. Our hypotheses are supported by empirical results from a sample of venture-backed startups in the biopharmaceutical industry.

Employee entrepreneurship in response to non-compete enforceability

Employee entrepreneurship is an important source of new ventures and economic development. However, employee entrepreneurship is affected by formal institutions such as non-compete agreements. Non-compete agreements stipulate that an employee may not work for a competitor or create a new competing venture, for some period of time and limited scope. We argue from the institutional perspective that employee responses to non-competes can range from compliance, compromise, defiance, avoidance, to manipulation. We test hypotheses predicting four of these five potential responses using a cross-country measure of non-compete enforceability and sample of employee entrepreneurs. Our results indicate that a country’s non-compete enforceability is associated with increased intrapreneurship, reduced spinout entrepreneurship, and more spinouts involving new products or services, especially when employees enter the same industry as their parent firm. These results help to clarify the influence that non-competes can have on the paths that employee entrepreneurs take.

Inalienable Human Capital and Debt Choice: Evidence from Quasi-Exogenous Shocks

Hart and Moore (1994) theoretically analyze how inalienable human capital affects debt contracting. We examine, empirically, how firms address the increased threat of losing inalienable human capital by choosing between private and public debt: Following the staggered rejection of the inevitable disclosure doctrine (IDD) that facilitate the outflow of key talents to rivals, treated firms significantly increase the reliance on private debt financing. Evidence from state-level noncompete enforceability shocks further confirms our main findings. Our overall evidence indicates that flexible renegotiation and timely monitoring are important benefits of private debt in reacting to the risk of losing human capital.

Managerial career concerns and the content of corporate disclosures: An analysis of the tone of earnings press releases

This study examines how the narrative content of corporate disclosures is affected by managers’ career concerns, measured by the enforceability of noncompete provisions in employment contracts. We provide empirical evidence that career concerns lead managers to manipulate the content of corporate disclosures by inflating the tone of earnings press releases to convey a more optimistic picture about the firm’s financial performance. We ensure the causality of our findings by exploiting changes to noncompete enforceability following court rulings. We also show that tone inflation is stronger when CEOs are younger, less capable and less experienced, as well as for managers of firms with more independent boards, more analysts following and better governance.

PRICE‐PARITY ADJUSTMENTS SHOULDN'T BE A TRADE SECRET: STATE‐LEVEL PRICE PARITY AND ASSESSMENT OF COVENANTS NOT TO COMPETE ENFORCEABILITY

This paper demonstrates the importance of making regional cost adjustments and questions the validity of papers using nationwide compensation to assess noncompete enforceability and other policies without regional price‐level adjustments. Numerous papers in recent years do not incorporate the cross‐sectional analog to inflation adjustments. Using the Bureau of Economic Analysis Regional Price Parity (RPP) index, the results of a representative policy analysis study are analyzed with, and without, parity adjustment. We show that typical results demonstrating broad negative economic effects from noncompete covenants may be an artifact of using nominal, nonparity‐adjusted data. (JEL C18, R1, J31)

How Firms Actually Use Non-Competes and Why it Matters

This study presents the first qualitative evidence on why and how firms actually use non-compete clauses in employment contracts. While the majority of the extant literature on non-competes focuses on the outcomes of non-compete enforceability at the state level, no studies to date look at the actual behavior of firms that use non-competes. Utilizing qualitative data from 32 interviews in three different innovation clusters, this study explores the motivations behind why firms use non-competes and how the use of non-competes influences firms’ behavior toward employees. The study finds that contrary to the assumptions of the rational actor model used to defend non- competes (e.g. firms invest more in employees’ human capital when employees are bound by non-competes), firms do not change levels of human capital investments based on whether or not their employees are bound by non-competes. I offer possible explanations for this discrepancy, and suggest ways to improve the rational actor model to account for actual firm behavior and thus improve the model’s stability and predictability.

Consider This: Training, Wages, and the Enforceability of Covenants Not to Compete

Using data from the Survey of Income and Program Participation, the author examines the effect of noncompete enforceability on employee training and wages. An increase from no enforcement of noncompetes to mean enforceability is associated with a 14% increase in training, which tends to be firm-sponsored and designed to upgrade or teach new skills. In contrast to theoretical expectations, the results show no evidence of a relationship between noncompete enforceability and self-sponsored training. Despite the increases in training, an increase from non-enforcement of noncompetes to mean enforceability is associated with a 4% decrease in hourly wages. Consistent with reduced bargaining power, noncompete enforceability is associated with a reduction in the return to tenure, and less-educated workers experience additional wage losses in the face of increased enforceability relative to more-educated workers. Suggestive evidence indicates that policies that tie the enforceability of noncompetes to the worker receiving additional consideration in exchange for signing a noncompete are associated with higher wages.

Strategic human capital management in the context of cross‐industry and within‐industry mobility frictions

Research Summary: We develop and test a theory examining how frictions that restrict mobility across industries and frictions constraining mobility within an industry can co‐occur to effectively isolate individual human capital, ultimately changing the firm's make‐versus‐buy decision for human capital. Empirically, we demonstrate that when cross‐industry frictions in the form of limited skill transferability and within‐industry frictions in the form of noncompete enforceability are both present, employees exhibit longer tenures, firms hire workers with less initial experience, firms change the amount and nature of training provided, and wages marginally increase. These findings suggest that sufficiently strong and complementary mobility frictions shift the emphasis of firms’ human capital management practices toward internal development of human capital relative to acquisition on the external market.Managerial Summary: In the face of frictions to employee mobility both within and across industries, which we capture empirically using measures of noncompete enforceability and limited skill transferability across industries, firms tend to hire less experienced workers, such workers exhibit longer tenures, and firms invest more in their training, particularly in the development of new skills. Our findings imply that for firms operating under such complementary frictions, better hiring and internal development capabilities are particularly important for performance, while those firms without such capabilities may benefit from considering ways to circumvent the mobility frictions, including moving out of the focal state or lobbying for different noncompete laws.

Enforceability of non-compete covenants, discretionary investments, and financial reporting practices: Evidence from a natural experiment

Non-compete covenants are widely used in employment contracts to promote employee stability. Using legal amendments of non-compete enforceability as a natural experiment, we find that as non-compete enforceability increases, firms display an increased likelihood of meeting short-term earnings benchmarks, lower discretionary expenditures, and declining future performance. These effects are more pronounced when CEOs have lower ability or shorter tenures, and when firms have more growth opportunities or operate in localized industries. Our results suggest that managers actively adapt investment and financial reporting practices to the changing environment that affects their contractual relations with firms.

Non-Compete Enforceability and Inbound Open Innovation: The Impact of Human Capital Strategies

Prior research generally posits that non-compete agreements impede employee mobility and therefore negatively impacts so- called inbound open innovation, defined as the use of external knowledge in...

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

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.

Local Tournament Incentives, Firm Performance, and Firm Risk

I study the effect of local tournament incentives for CEOs on firm performance and firm risk. I document that local tournament incentives positively affect both firm performance and risk taking. My empirical tests use staggered state-level variation in both non-compete enforceability and the inevitable disclosure doctrine (IDD) to identify shocks to local labor mobility, thereby exogenously affecting the probability of a CEO winning a local tournament. The effect is stronger among firms that are ex ante more likely to be affected by local tournaments. Further, firms spend less on R&D expenditures, reduce earnings management, and have a lower cost of equity capital following an exogenous decrease in tournament incentives. My results are robust to various controls and alternative measures of local tournament incentives. Overall, the findings support the hypothesis that rank-order tournaments affect local executive labor markets.

Redirect and Retain: Why and How Firms Capitalize on Noncompete Enforceability in Technical and Business Occupations

Covenants-not-to-compete play an important role in the strategic management of human capital because they have the dual effect of directing departing employees away from competitors and reducing mobility overall. We combine the literature on noncompetes with the literature on human capital transferability to develop a theory of how the enforceability of noncompetes differentially impacts the management of technical and business occupations. Using a difference-in-difference estimation strategy, we demonstrate that when noncompetes are more enforceable, their impact on new hire experience, wages, training, and tenure for technical employees is stronger than on business employees, which is in turn stronger than unaffected occupations. We argue that the heterogeneous responses to noncompete enforceability for technical and business occupations are consistent with cross-occupational differences in skill transferability.

Labor Market Mobility and Expectation Management: Evidence from Enforceability of Non-Compete Provisions

This study examines how managers’ use of expectation management is affected by labor market mobility, measured with the enforceability of non-compete provisions in employment contracts. We find that managers in states with stricter non-compete enforcement are more likely to manage analyst expectations downward, consistent with labor market immobility exacerbating managers’ incentives to ensure meeting expectations. Moreover, we find the effect to be more pronounced for less capable and more junior CEOs, for firms with more intense monitoring, and for firms in more homogenous or more competitive industries. Results from quasi-natural experiments and instrumental variable approach suggest that non-compete enforcement causally affects the use of expectation management. Finally, investors seem to discount the premium on achieving earnings targets through expectation management for firms in high non-compete enforceability states.

Locked In? Noncompete Enforceability and the Mobility and Earnings of High-Tech Workers

We examine how the enforceability of noncompete contracts affects the length of job spells and the level of wages. We expect noncompete enforceability to lengthen job spells, but its impact on wage...

Training the Enemy? Firm-Sponsored Training and the Enforcement of Covenants Not to Compete

This study examines the effect of noncompete enforceability on training and wages. An increase from non-enforcement to mean enforceability is associated with an 11% increase in firm-sponsored training, no effect on self-sponsored training, and a 1.7% decrease in average wages. The small, negative wage effect averages together contrasting positive effects for low earners but negative effects for high earners. One noncompete policy that does not reduce training but is associated with higher wages throughout the distribution is the requirement that firms provide workers with consideration beyond continued employment in exchange for signing noncompetes.

Enforcing Covenants Not to Compete: The Life-Cycle Impact on New Firms

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.