States and Employers Should Approach Non-Compete Contracts With Caution

Author: Suman Ghosh, Ph.D.

Release Date: Apr 13, 2017

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

California’s Silicon Valley is an American success story unlike any other. This unrivaled hub of technology and innovation attracts the best and brightest from around the world, developing products and services that fulfill wishes consumers didn’t even know they had.

But it’s the one thing Silicon Valley doesn’t have that may be the key to its continued success. Non-compete agreements, which prevent employees from accepting employment in a competing firm for a specified period of time after they leave the current employer, are automatically void as a matter of law in California.

By restricting worker mobility, these agreements limit the flow of knowledge to competitors. There are widespread differences from state to state in the extent to which non-compete clauses can be legally enforced. While California has made such contracts completely unenforceable, other states such as Texas and Massachusetts are known for being very permissive in their enforcement of such contractual employment restrictions.

The logic behind these contracts is that firms can invest in these workers without the fear that they will move to other firms and hence make their investments futile. The negative aspect of such contracts is that they in turn forcefully prevent worker mobility, which is extremely important as a conduit through which knowledge is transferred across firms.

After studying these agreements with my colleague Kameshwari Shankar of The City College of New York, we argue that the success of non-compete clauses depends on the industry. In certain labor markets, such as healthcare, where firm-sponsored training for employees is widespread, allowing employers to negotiate mobility restrictions with their workers facilitates such investment that enhances the firm’s productivity.

At the same time, if the growth of certain industries is strongly dependent on incentivizing workers to invest and productively use their human capital through a competitive wage-setting process, such as the IT industry, it may be desirable to carve out exceptions to the enforceability of non-compete clauses in those cases rather than weaken enforcement across the board irrespective of industry specifics.

Suman Ghosh is a professor of economics and Stone Fellow at Florida Atlantic University’s College of Business. The opinions expressed in this article are those of the author and do not reflect or represent the opinions of Florida Atlantic University.