Should Non-Compete Agreements Be Non-Starters?

Non-compete agreements are likely the most contentious provisions in employment contracts. They have been used since the 15th century to prevent workers from joining rivals or starting a competing business for a prescribed period after their employment ends. 

Non-competes may be reviled but they are not rare. It is estimated that one in five American workers is subject to such clauses — everyone from executives to fast food workers. One survey of private sector employers indicated that, in roughly half of responding establishments, at least some employees were required to sign a non-compete. 

Employers generally justify such clauses as a way to protect their investments, whether in intellectual property that is not patented, in upskilling workers or in intangible relationships with key clients or customers. Unspoken is the fact that non-competes can also be used to block competitors from poaching star performers with promises of better pay or working conditions.

Detractors argue that non-competes reduce workers’ bargaining power for negotiating higher pay or better conditions and prevent workers from either launching new companies or moving to firms where they’d be a better fit. Indeed, studies have shown that firms are under less pressure to pay competitive wages to those who have signed a non-compete and that executives move less and have longer tenures in jurisdictions that enforce non-compete agreements. 

Who has the stronger case? A new study called “Training and Job Separation in Imperfect Labor Markets: The Case of Non-Compete Agreements” weighs in with a closer look at the incentives for workers and firms to use non-compete agreements and studies their effects on the labour market. 

How was the study designed? 

The study is based on a game-theory model that is validated based on U.S. data from the National Longitudinal Survey of Youth between 2017 and 2019. Researchers studied the characteristics of non-compete signers and analyzed the effects of these provisions on job tenure, employer-provided training, wages and wage growth. The sample included 5,081 workers, aged 32 to 38. 

What did the study find? 

• Non-compete agreements are more likely to be used in knowledge-intensive industries and in higher wage industries where knowledge is easily transferable. They are least likely found in public administration, education, health and social services. 

• Employees who signed non-competes remain with their employers for three more months than those without such agreements and are five percentage points less likely to leave their jobs than their counterparts. 

• Non-competes appear to increase the likelihood of employer-paid training, though a causal link was not established. In industries where such agreements are popular, non-compete signers are six percentage points more likely to receive employer-paid training. 

• Non-compete signers earn 25 per cent more than individuals without non-compete agreements, which reflects a one-time bump from signing. Non-compete agreements, however, are not associated with a continuous rise in wages. 

What do I need to know? 

Given their anti-competitive nature, non-compete agreements are in the crosshairs of regulators in North America and Europe. In Canada, such provisions can be found in many employment contracts. But they are phantom clauses that are largely unenforceable under common law. In December 2021, Ontario became the first province to bar employers from entering into non-compete agreements with employees.

In the U.S., the Federal Trade Commission (FTC) has proposed rules to ban employers from entering non-compete clauses with their workers, including independent contractors, and to rescind existing non-competes. The FTC estimates that the new rule would increase workers’ earnings by nearly $300 billion per year and double the number of companies founded by a former worker in the same industry. 

In Europe, U.K. regulators recently proposed limiting the length of non-competes to three months. The Netherlands is considering similar limits. 

Regulators will likely not get much pushback, but this study is a cautionary tale. The researchers say that mobility frictions generated by non-compete agreements can be “a double-edged sword”: On the one hand, these clauses disrupt the labour market and perpetuate mismatches between employer and workers, partly because of the high cost of buying out the employment contract. On the other hand, they appear to encourage firms to invest in employee training when they know the employees will stick around. 

“Our results imply that blanket bans on the enforcement of non-compete agreements may have short-term gains as workers flow into jobs in which they are more productive but have long-term consequences in terms of a less-skilled workforce,” the researchers note in their working paper. 

It’s not like non-competes are the only way employers can protect their intellectual property or other valuable investments. According to an FTC report, the record to date shows that in U.S. states where employers cannot enforce non-compete clauses, “industries that depend on trade secrets and other key investments have still flourished. This shows that employers have other ways of protecting these investments.” 

No doubt in coming years, these alternatives will draw greater interest. 

Study Title: Training and Job Separation in Imperfect Labor Markets: The Case of Non-Compete Agreements 

Authors: Bhargav Gopal (Smith School of Business) and Xiangru Li (Columbia University) 

Published: Working Paper available for download