Non-Compete Agreements: The Good, the Bad, and the Ugly

8/14/14Follow @KauffmanFDN

Twenty years ago, renowned researcher AnnaLee Saxenian wrote a book called Regional Advantage, which compared the development of two high-tech regions, Silicon Valley and Route 128. Everyone in the tech world knows how this story played out: In the face of global competition and technological trends, Silicon Valley reinvented itself and roared ahead, while Route 128 staggered in comparison.

The reason, Saxenian wrote, was the fluidity of the Valley compared to Route 128: ideas and individuals in northern California could more easily move between companies and, especially, in and out of startups and big corporations than they could outside Boston. As a result, the speed of innovation and adaptation was faster. Law professor Alan Hyde later termed this a “high-velocity labor market.”

One of the reasons for the diverging fates of the two regions, and one of the underpinnings of a high-velocity labor market, was the different treatment of non-compete agreements. Put simply, Massachusetts enforced them and California didn’t. People who left a job in California and joined a competitor, or started a new company in the same space, could do so without fear of being sued by their former employer. This policy difference, of course, was not the exclusive reason for the divergence, but it did matter a great deal, and research has continued to show that a state’s stance toward non-compete agreements is an important factor shaping its entrepreneurial ecosystem.

A few years ago, an alliance of investors pushed for the complete elimination of these agreements in Massachusetts, but the effort failed. Last month, the state government had an opportunity to revisit the issue and, with a big push from Governor Deval Patrick, looked like it could be on the brink of banning non-compete agreements. Ultimately, the effort again failed, and non-compete agreements remain very much an enforceable employment arrangement in Massachusetts.

The issue hasn’t just divided entrepreneurs and big corporations (not to mention policymakers)—it has also sometimes confused those in the entrepreneurial community. A Cambridge entrepreneur complained to The Wall Street Journal last year that non-compete agreements made it hard for his startup to hire software engineers. Yet, in the very next line, the founder admitted to requiring his employees to submit to the same employment restrictions.

To Enforce or Not to Enforce

So what’s the right approach? Should a state enforce non-compete agreements or not? The unsatisfying answer is, it depends. It depends on the economic balance in a state; it depends on a state’s policy priorities; and it depends on the types of economic benefits a state wants to promote.

On one hand, a lax policy toward non-compete agreements is an important piece in creating a “high-velocity labor market” that encourages mobility of workers. On the other hand, companies may refrain from certain projects or investing in the human capital of their employees if there aren’t certain labor market restrictions.

(It’s important to note here that a firm’s trade secrets can still be protected even if non-compete agreements are not signed or not enforced. California, famous for turning its nose up at non-compete agreements, still protects trade secrets and has passed, for example, the Uniform Trade Secrets Act.)

There are, perhaps not surprisingly, research findings that support both sides of the argument. A 2011 study that looked at U.S. patenting activity between 1990 and 2000 found that public companies pursued riskier … Next Page »

Dane Stangler is vice president of Research & Policy at the Ewing Marion Kauffman Foundation. Follow @KauffmanFDN

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