Non Compete Clauses Reduce Innovation

The NYTimes has a good piece today on the increasing use of noncompete clauses, clauses that say that if you leave a firm you cannot work for a competitor typically for a period of 1 or more years.

Noncompete clauses are now appearing in far-ranging fields beyond the worlds of technology, sales and corporations with tightly held secrets, where the curbs have traditionally been used. From event planners to chefs to investment fund managers to yoga instructors, employees are increasingly required to sign agreements that prohibit them from working for a company’s rivals.

Non competes agreements (NCAs) are dangerous in my view because they put firms into a prisoner’s dilemma: Non competes benefit firms but harm industries by reducing innovation.

Today we all know about Silicon Valley but in the 1950s and 1960s the place for technology was Route 128 in Massachusetts which Business Week called “the Magic Semicircle”. The magic semicircle contained technological leaders like DEC and Raytheon and intellectual powerhouses like Harvard and MIT – this was at a time when Silicon Valley was mostly fruit trees.

When William Shockley left Bell Labs for the Valley it was not considered a promising move. And indeed something strange happened. Shockley wasn’t a very nice person, he couldn’t get any of his former colleagues to come work for him, and within a year of starting his firm in Mountain View, eight of Shockley’s researchers, who called themselves the “traitorous eight,” resigned. The traitorous eight, started Fairchild Semiconductor. Two of them, Robert Noyce and Gordon E. Moore, later left Fairchild to form Intel Corporation. Other people leaving Fairchild Semiconductor started National Semiconductor and Advanced Micro Devices. So it was in this branching off process of new firm creation that Silicon Valley was born.

Now here is the point, if Shockley had started his firm in Massachusetts or in pretty much any other state, the traitorous eight probably would not have left to start their own firm because they would have signed a standard non-compete agreement prohibiting them from competing with their former employer for 18 to 24 months. In California, however, the courts have consistently refused to enforce non-compete agreements. An employee who leaves one company can join a new company and start work the next day and they can do so regardless of any agreement.

Silicon Valley could not operate if non-compete agreements were enforced. Silicon Valley is a hyper-mobile workforce. Moreover, it’s precisely in the circulation of workers that Silicon Valley has one of its advantages the diffusion of new ideas. The key to Silicon Valley and much innovation today is the diffusion, the combination, the integration of different sorts of knowledge and worker mobility has been a big part of this. Not just worker mobility between firms in Silicon Valley but also immigrants, circulation between different countries, university-firm partnerships and so forth.

Firms who come to Silicon Valley know that they cannot use NCA to protect their innovations but they come anyway because the opportunity to learn from other people exceeds the costs of other people learning from you. Thus, worker mobility and the inability to protect IP by restricting mobility is bad for an individual firm but good for the industry as a whole, good for innovation, good for workers and good for consumers.

(Drawn from a talk I gave at a Google Big Tent event in Korea.) Hat tip to Loweeel in comments for some edits.


You should find a better example than Silicon Valley. Firms there have found a way to around California's ban on non-compete agreements. Tech companies have entered into different (albeit illegal) arrangements:Horizontal non-poaching/non-recruiting agreements.

For example:

""Mr. Jobs wrote: "I would be very pleased if your recruiting department would stop doing this." Mr. Schmidt forwarded Mr. Jobs's email to undisclosed recipients, writing: "I believe we have a policy of no recruiting from Apple and this is a direct inbound request. Can you get this stopped and let me know why this is happening? I will need to send a response back to Apple quickly so please let me know as soon as you can."

Mr. Geshuri told Mr. Schmidt that the employee "who contacted this Apple employee should not have and will be terminated within the hour." Mr. Geshuri further wrote: "Please extend my apologies as appropriate to Steve Jobs. This was an isolated incident and we will be very careful to make sure this does not happen again."

The growth of Silicon Valley into what it is today is a result of NCAs being unenforceable in California. This is a stock lesson from every entry-level business course. Even law schools now teach this to their first year classes.

The fact that Silicon Valley may have moved on and found other ways to de facto have NCAs in the modern day does not change the historical importance of NCAs to the development of SV.

This is too parochial. Evidence from the Google case indicates the companies involved in the non-poaching agreement include: Genentech, Intel, Apple, Paypal, Comcast, Microsoft, Novell, Oracle, Sun Micro systems, DoubleClick, illuminta, Intel Intuit, Ogilvy, WPP, IBM, AOL,, Clear Channel, Dell, Earthlink, Virgin Media etc (Source linked below).

I would be a little surprised to find out that Alex thinks Anti-trust law is an effective remedy to these kind of horizontal agreements. The truth is that business owners in Silicon Valley are also reluctant to train and invest in their workforce... if that workforce can leave and go work for one of its competitors freely. The firms above are among the MOST innovative in the world. The same incentives govern large and small companies together...

Silicon Valley's success should be credited to many reasons (access to capital, educated work force, proximity to research institutions, etc). The idea that non-compete law is the magical source of this innovation is wrong. It's not even clear that weather isn't a bigger factor (I'm not kidding).

Well, outside CA you can do it legally via non competes.

Yes, the Silicon Valley firms tried to work around the lack of non-competes by informal agreements. But hey, at least we can now sue them for that.

but that is a backdoor to antitrust lawsuits

I hope the have to pay steeply via antitrust.

As terrible and illegal as it was for Google, Apple, etc. to try and create their own non-compete agreement, it's nothing compared to a legally binding agreement that would lock you out of an entire industry.

There's a less well-known alternative candidate to William Shockley as Father of Silicon Valley: Fred Terman:

It's amazing the stuff that employers are trying with software developers, when the market for their labor is incredibly tight. These things will be horrible as soon as the slightest thing changes.

Non-competes have some value: if I sell my business to you, including my goodwill, you don't want me setting up a competing business next door. Even California will enforce a certain limited class of non-competes that pass a strict test.

Worst non-compete I was ever asked to sign had an unholy trifecta of 1) we own your IP for a year after you stop working, 2) you cannot work for any customers or competitors [as a consulting company, this is potentially every possible employer], and 3) you agree this doesn't restrict your ability to earn a living.

I walked away, but was also in a position where I could afford to walk away. Can the guy being hired to sweep floors at the supermarket afford to say no?

I think there's a huge gap between what's in a non-compete versus what courts will actually enforce. I think your trifecta might be quite hard to get a court to enforce.

In not-California, non-competes get thrown out if they substantially impair your ability to perform work in your profession.

The third clause was put in there particularly to find someone to be a test case for "no, you promised you could find work in your profession." I have no desire to be that test case.

My contact at the firm said, like you say, that it was probably not enforceable. But he couldn't get the company to take the clauses out. "Probably not enforceable" is the worst possible outcome if you want clear legal guidelines.

You're right, of course, but the clause is asking you to assert a thing you can not possibly know--what the labor market will be like at some unknown point in the future, when you are looking for a new job. Basically unenforceable, and I've signed similar agreements in the past, half hoping that they'd try to come after me. It's only there for intimidation. Just wondering: did the legal genius who drafted it include a severability clause?

True. California non-competes have for many years been more onerous for, or at least enforceable against, employees than non-competes in other states.

California does indeed enforce noncompetes if they're tied to equity. In Alex's examples courts would've enforced noncompetes against those guys had they been issued founders stock. Also, interstate companies can sometimes get NCAs enforced in a race to the courthouse (see the Medtronics case).

The non-competes that are enforceable in California are exactly the same as the non-competes enforceable elsewhere. The main difference is that people in California believe that they aren't enforceable. It's possible that there is also a difference in speed of resolution.

This is just wrong. Non-competes are only enforceable in California in the context of the sale of a business, and even then there are limits (not all employees, reasonable in scope, etc.) In many other jurisdictions, they are much more broadly enforced. Plus some jurisdictions follow the doctrine of "inevitable disclosure" where the former employer can argue (even without a non-compete) that the moving employee can't do their new job without disclosing trade secrets.

As far as I can tell, the law in most states only allows non-competes on the grounds of poaching clients. Maybe judges don't care about the law.

As you admit, your second sentence isn't about non-competes.

Daniel McKinnon, who had been a hairstylist in Norwell, Mass., lost a court battle with his former employer who claimed that Mr. McKinnon had violated the terms of his agreement when he went to work at a nearby salon.

Try reading my comment.

Douglas, Rusty is correct.

Non-competes in California are outlawed by a fairly unique state statute - California Business and Professions Code section 16600:

"Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void."

The exceptions which follow are for partners leaving partnerships and sales of business involving goodwill. California courts have pretty consistently interpreted this as written in the years since it was enacted. So, the piece is correct, there are fundamental differences separating California from the rest of the US.

Chefs, investment fund managers and yoga instructors aren't being asked to sign NCAs to maintain trade secrets. They are being asked to sign NCAs so they don't poach customers. This is about people, not ideas. There are very few advantages to cross-pollination in these cases.

Non-solicitation is separate from non-compete.

Yes, but you don't necessarily have to solicit customers in these fields. All you have to do is show up. An announcement in Pensions & Investments that a manager has moved to another fund is enough to attract investors from his previous employer without him contacting them. In these cases, the NCA is aimed at retaining customers.

Right, but in that case the argument against NCAs is even stronger. No argument for NCAs if all they do is cartelize.

The default assumption should be that the government will allow voluntary contracts to be made, and that it will enforce those that are made. That should apply to non-compete contracts.

It is obvious why companies will sometimes want to have a non-compete contract with a potential employee. If such contracts are disallowed they may not hire someone they would have hired, or may structure their operations differently from how they would have done, and this may be detrimental to the public interest.

In the experience I had with the company I describe above, I was told by my contact that I should just sign it, because "it's probably not enforceable anyway."

How detrimental is it to the public interest to have a bunch of candidates out there with contracts that are "probably not enforceable" but decide just to pass on the candidate anyway.

There are a very very small class of transactions that would only happen with non-competes. NDAs, IP assignments, and non-solicitation clauses cover everything else.

(Second paragraph should be

How detrimental is it to the public interest to have a bunch of candidates out there with contracts that are “probably not enforceable,” but employers decide just to pass on the candidate anyway to avoid murky legal issues?


The operative word is voluntary.

Maybe if I am a talented software engineer with access to the key proprietary algorithms, I have alternatives.

Is it voluntary if I have to sign a non-compete to be a yoga instructor or carpet installer, when my alternative is getting evicted from my apartment because I can't make rent?

The software engineer could get a job with the same skillset (software) but in another industry (telecom to insurance, for example) but the Chef cannot do something else that does not compete. Move from French cuisine to Italian perhaps?

Buzz! Wrong answer! Contracts allow private parties to bind each other under the law, and then use the apparatus of the state--courts, sheriffs, prisons--to impose their wills on each other. Contracts are best understood, I believe, as privately made extensions of the law. As such, legal contracts (as opposed to "word of honor between gentlemen" or whatever) are closely constrained by the law as to form, subject, and effect. The government is intimately involved in every legal contract that is ever executed: that is what a contract is.

There is no general presumption along the lines you suggest. Contracts have to be made for a valid purpose to be enforceable, and it is exactly the laws in force, as enforced by the executive and interpreted by the judiciary, that determine what constitutes a valid purpose.

"There is no general presumption along the lines you suggest."
This is incorrect as a matter of law. If one party claims that a contract is unenforceable as a matter of public policy (such as, it violates a public policy against restraints on trade), the burden is on that party to show that the contract is unenforceable. In other words, this kind of contractual invalidity is an affirmative defense. This amounts to a "general presumption" that voluntary contracts may be made.

IOW, the rule is that a contract is enforceable unless it fits into a few categories of proscribed contracts. The rule is *not* that a contract is unenforceable unless it fits into a few categories of permissible contracts. It's a big difference.

Well, we may be talking past each other. If by "contract," you mean to say an agreement between two legally competent persons, made for a legal purpose, involving an offer, an acceptance, and consideration, undertaken voluntarily and without coercion, et cetera, et cetera, (and you're prepared to say that an invalid contract was never a contract in the first place) then, sure. But I think you've assumed six or seven can openers by this point. When ordinary people say "I signed a contract," they don't mean that the legality of the thing has been fully adjudicated and a copy of the ruling was sent back in time so that we'd all know it.

reminds me of how the music and movie industry's failed attempts in the late 90's and early 2000's to crack down on content distribution in an effort to save their dying industries.

Non-compete clauses benefit the employer and harm the employee (because the employee cannot start his/her own firm or go elsewhere). These clauses will exist only if the benefit to the employer is greater than the cost to the employee. It's like any other employer-employee contract. Economists generally do not want the government or courts to interfere in contracts unless externalities are involved. Most of the innovation benefits accrue to one side or the other in this employment contract. Alex has to show that there are externalities that accrue to others in the industry and that these externalities are greater when covenants not to compete are disallowed.

Isn't that what he did with the post? The creation of Intel, AMD, NatSemi led to the level of technology we have now; that level would have been much lower if everyone stayed in Boston (says the counterfactual).

It's a little bit stronger than a counterfactual. Lots of clever people were still in Boston while Silicon Valley was taking off. I have no idea how important NCAs were in that difference though.

Non-competes are not allowed for lawyers. That's probably why innovation is so high in the legal field :)

That's true. However, if you view the lawyer as the agent of the principal (the firm's client), a lawyer may not act adverse to the principal (the former client) (taking information and using it against a former client) as it would if you treated the former client as if it were the former employer. In some sense, ethical rules bind more than covenants and it is just a question of who you define as the competitor, the principal or the agent.

This sounds like an argument for a Pigou subsidy to firms which produce the externality of skilled employees who are more valuable to a competitor than they are to the firm from which they exit.

That might be difficult to assess, or have perverse incentives if too simple a metric is used (for example, difference in pay).

Non-compete clauses suck because they give the employer too much power over the employee. I would restrict the clauses to former owners and, perhaps, high level managers.

In theory, employers pay higher wages to employees in exchange for the agreement. But the costs are hidden. I would propose that showing the costs would be better. Would there be much disagreement to having employers put a portion of a worker's pay into a fund (not available to the employer) so that the funds would go to the employee after one or two years not competing with the employer. The employee would have the burden of showing that he/she did not compete during that year (perhaps by having to provide tax returns) and, if he/she could not do so, the money would go to the employer. If the fund increased every year of employment, long term employees (and, theoretically, those who could harm the employer most), would have the greatest incentive not to compete with the former employer.

Also, any non-compete or similar agreement would be unenforceable for firings, other than "for cause". That is, if the employee could receive unemployment compensation, the agreement would be void.

"Firms who come to Silicon Valley know that they cannot use NCA and trade secrecy law to protect their innovations but they come anyway because the opportunity to learn from other people exceeds the costs of other people learning from you."

Alex, you're simply incorrect here, and some edits reflecting the inaccuracy of the original post (and removal of the glaringly inaccurate statements) would be appropriate here. Maybe you should have discussed with your colleague Prof. T.J. Chiang, who taught the Trade Secrets course at the law school this past semester.

As I'm sure he could tell you, and as is obvious to anybody whose practice even touches on the issue, trade secrecy law is alive and well in California (CUTSA --, and is widely available to protect all sorts of innovations, know-how, customer lists, and the like. Even though they don't recognize the inevitable disclosure doctrine, trade secret law and injunctive relief for the same remain widely available, including in California. The alleged "inability to protect trade secrets" reflects some fictional world, not California.

You are correct. What I meant to say was that they cannot use NCA to protect trade secrets not that they cannot use trade secrecy law (I also acknowledge that this is disputable given recent cases). In anycase, thanks, I cut the reference to trade secrecy.

"Firms who come to Silicon Valley know that they cannot use NCA to protect their innovations but they come anyway because the opportunity to learn from other people exceeds the costs of other people learning from you. Thus, worker mobility and the inability to protect IP by restricting mobility is bad for an individual firm but good for the industry as a whole, good for innovation, good for workers and good for consumers."

Sentence 2 seems to contradict sentence 1. Sentence 1 suggests that NCA unenforceability is good for individual firms (on a NET basis - i.e. it applies to you & your competitors) as well as for the industry. Just like the prisoner's dilemma.

There's an intersection here with Piketty's analysis. Consider the political economy of a world where capital claims an increasing share of national income: it will necessarily use the increased power it has to further increase its share. Why would a summer camp foist a non-compete clause on its teenage instructors? For no other reason than it can. I'm sure a smart modeler can demonstrate how this is a totally rational thing to do, and how it would have a further negative impact on labor's share of national income.

I agree with this post, although California is extreme, and you can write reasonable (limited in duration, scope and location) covenants.

Of course, this means that you end up relying more on patents to protect your IP.

See my comment above. There is no reasonableness exception. Unless you are in a partnership or unless you are buying/selling a business, all covenants are void.

It is true that if someone is stealing trade secrets to unfairly compete, normal IP remedies are available.

At the moment these are nearly free options for employers and can be significantly costly to the employee. There is an asymmetry of bargaining power and consequence here that really needs to be recognized.

I'm of the opinion that the correct way to go here is the California option: no non-competes except in connection with the sale of a business.

if Shockley had started his firm in Massachusetts...they would have signed a standard non-compete agreement

Were non-compete clauses popular in the 50s?

Non-compete allows for increased investment: if I know the skill I build up in my worker is likely to be taken by other competitors, I would try to protect that investment. Non-compete looks one way to do this.

That must explain the lack of skilled labor in Silicon Valley....

I've never understood this logic. What exactly is this investment?

Most of the formal on-the-job training that companies provide isn't particularly transferrable: here's how we do process X, that's how we troubleshoot Y, and neither X nor Y are going to be exactly the same at another company. Some companies do offer tuition benefits, but these are covered by explicit repayment agreements (e.g., if you leave before X months, you must repay the money given to you).

So far I've learned advanced excel, cognos, business objects, and some SQL through on the job training. Database work and financial analysis is very transferable, as are negotiation and contract skills.

I'm also (unfortunately) learning to golf, mainly so my team can accept a higher percentage of the invitations we receive.

If these are easily transferred then non compete is no good.

Perhaps. I don't have one, nor do most of my coworkers outside r&d and sales. Chances are very low we'll jump to a direct competitor because any of them would involve moving, and people don't take a job at this company if they want to move. There's a group of five to ten large employers in our area that tend to pull from the same employee pool.

If I left tomorrow, I'd be replaced by a peer from one of those companies, or they'd hire a less senior analyst and develop them. The training cost is offset by a lower salary. I don't have any trade secrets to take and my contact list is mostly for vendors.

How about raising his salary?

An alternative interpretation is that you know your employees are trapped in their current jobs, so you don't actually have to worry about keeping them happy since their movement is restricted.

I would have expected more defenders of Freedom of Contract (the freedom of individuals and groups to form contracts without government restrictions) among readers of this blog. In my state (Florida) the general rule is that non-compete covenants are enforceable if necessary to protect a legitimate business interest and if reasonable, both as to geographic scope and time. Lots of wiggle room in that standard, giving the trial judge wide latitude in determining which covenants satisfy the standard; indeed, the latitude is so wide few cases actually make it to trial, the outcome being so unpredictable, and are settled. I represent physicians, physician groups, and medical facilities, and non-compete covenants are standard provisions in our contracts. Consider a medical group that wishes to hire more physicians. Would they do it, and invest the time and resources, if the physician could quit after a few years, open an office next door, and take patients with her? I let my clients know the general rule but I let them know that there's little predictability, with the outcome often dependent on the attitude of the trial judge (does he believe in Freedom of Contract?) who gets the case. Moreover, I let them know that the trend in Florida and elsewhere is to limit the enforcement of restrictive covenants against physicians to non-solicitation (of patients and contracts).

Yes they would, they don't have a choice. The same thing happens to lawyers all the time. It certainly does have an effect at the margin, though, in terms of e.g. not allowing associates to have client contact, etc.

Hey, how about you have all the "freedom to contract" you want, but you can't bring the coercive apparatus of the state (police, courts, and prisons) to bear to enforce your "freedom contracts?" Oh, you don't want that much freedom? You expect the courts to hear your case and the sheriff to enforce judgments? I'm reminded of Kim Stanley Robinson's observation that libertarians are basically anarchists who want police protection from their own slaves.

There's a lot of freedom to contract with labor unions, too. If you don't want to join the union and pay dues that go to support a political party, no one's making you. Just don't take the job.

Naw, at some point it is in the interests of a nation trying to support a free market economy not to let law support coercion in contracting from a party that has wildly disproportionate power in the negotiations. Everybody gets to play, but everybody has to play fair. Granted, it's hard for law to regulate fairness, but that's a universal; if we're going to have law at all, that's what we have to have it for.

NCA are one of those things where employees usually underestimate the cost of them. Moreso the less lucrative the contracts get (high end managers may read those things, but chefs?)

Especially because its the collective effect (reducing competition among employers and lowering the salary scale for an entire class of employee) that hits the employees. Each employee can be bullied into it because their not signing means they will just hire someone else. However, once most of the workforce is in NCAs one doesn't have to bid up wages anymore because the employees have no leverage. Classic collective action problem.

Reminds me of my ZMP years. Right out of college, can't get a full-time job, so got a part-time tutor position with a sizable tutoring company. Had to sign a non-compete agreeement for that little service.

The traditional argument for NCAs --- that they protect the employers' "investment" in the employee and that they are part of freedom of contract --- is a seductive but I think flawed one.

If employers truly provide valuable training, etc., then in the absence of NCAs, employees will willingly accept lower salaries to gain such training for the same reason that students willingly pay tuition to schools. If employees are unwilling to accept lower salaries in the absence of NCAs, then that would be the market's way of telling us that the training/investment offered by the employers wasn't that valuable after all. Thus, we really needn't fear that abolishing NCAs will stop employers from investing in training of employees. There is a way to recoup training costs through salaries.

Regarding freedom of contract, as many have pointed out, there is a lot of uncertainty about enforceability of NCA terms at the time the contract is signed. Thus, the employer and employee aren't truly agreeing to contract terms since they may disagree in their own minds about which terms will ultimately prove enforceable and binding. Paradoxically, then, abolishing NCAs may actually enhance freedom of contract by allowing employer and employee to negotiate mutually agreed upon *binding* contract terms such as the reduction in salary in exchange for training mentioned above.

Related, if there is considerable uncertainty about the enforceable and binding terms of the NCA, then that could lead to loss of economic efficiency. Since neither employer nor employee know what the actual binding contract terms are, employers may discount the value of the NCA in deciding how much to invest in employees, how many trade secrets to share, etc. and employees may believe that NCAs are more onerous than they actually are, turning down job offers that they would have accepted otherwise. NCAs would appear to introduce unnecessary risk to both the employer and employee. Perhaps, this added risk is what leads to the inefficiencies observed in the states that allow NCAs.

My recent personal experience with non-compete clause boils down to this:
"If you dare to leave us, you will be unemployed for at least a year - guaranteed". That's pretty evil and should be outlawed.

In one fell swoop, we learn that Alex is both anti-property (against trade secrets) and against freedom of contract. I'm surprised George Mason hasn't revoked your tenure for taking these positions. You should move to Berkeley.

FYI, the governor of Massachusetts wants to move the Commonwealth toward the California model. Perhaps you should give some legislative testimony or otherwise weigh in favor. A little blog lobbying never hurts.

Comments for this post are closed