Optimal Enforcement of Noncompete Covenants

Author: Suman Ghosh and Kameshwari Shankar

Release Date: Sep 30, 2016

MEDIA CONTACT: Jim Hellegaard
561-319-2233, jhellegaard@fau.edu 

Noncompete covenants or covenant not to compete (CNC) are clauses in employment contracts inwhich the employee agrees not to gain employment with a competitor firm. In this article, we study the efficiency aspects of such contracts by incorporating the effect of labor mobility restrictions on knowledge transfer across firms, investment decisions by firms, and investment by workers. Following research that shows state-wise variations in the degree of CNC enforcement, we allow the strength of CNC enforcement to vary as a matter of regulatory policy and derive the optimal strength of enforcement.

We also look at how regulations around CNCs should be optimally designed when employers can use collusive agreements, such as “no poaching” agreements, as an alternative to noncompete clauses. Given recent allegations of employer collusion among large Silicon Valley firms, we argue for a cautious approach in designing policies on CNC enforcement.