Noncompete clauses may hold back the talent

When Google hired a top Microsoft executive, Kai-Fu Lee, two years ago it sparked a legal dispute over a noncompete clause in her contract.

by HBS Working Knowledge
Last Updated: 23 Jul 2013

These clauses forbid inventors and other professionals from offering their services elsewhere for a period of one or two years. Microsoft and Google eventually settled out of court, but such agreements affect careers and businesses in the US all the time.

Matt Marx, a doctoral student at Harvard Business School who is himself an inventor in the field of speech recognition technology with six patents to his name, has written a research paper on the impact on mobility of noncompete enforcement in Michigan.

Along with research associate Deborah Strumsky, and associate professor of technology and operations management Lee Fleming, their paper discovered that the impact of such clauses fell disproportionately on "star" or specialist inventors. The more cited an inventor's patents were in other patent applications, the more strongly their career choices would be affected by the agreements they had signed. These individuals were often forced to move state in order to continue their career or give up work for the period of the noncompete agreement.

Marx himself signed a noncompete agreement with a Boston firm and eventually moved to California where the courts would not enforce the agreement preventing him from working for another company.

The first recorded noncompete case was brought in England in 1414 when a dyer tried to stop a former assistant of his from setting up a shop in the same town. However, judges in the 15th century did not look favourably on this kind of monopolistic practice in a period of labour shortages following the Bubonic Plague. It was not until the Industrial Revolution that they began to enforce noncompetes.

In the US today there is something of a lottery regarding enforcement of noncompete clauses, as some states, such as California, generally refuse to enforce them while others such as Massachusetts do.

For companies, the difference between US states may encourage clustering of technology-based companies in states that take a lenient view on noncompete clauses, perhaps contributing to the growth of clusters such as developed in Silicon Valley. However the Marx research was not able to conclusively show that noncompetes played such a role in the location of firms.

Certainly, the impact of such clauses on companies and individuals can be severe. For example, in 2001 the CEO of SANgate Systems was forced to resign after just three months when a judge determined he had violated a noncompete he signed at EMC.

Studies have shown that noncompetes are almost ubiquitous, and especially so in venture capital-funded companies where investors want to protect their intellectual property. Non-disclosure agreements are used for similar reasons, but they are very difficult to enforce. Once an employee moves, even with good intentions they inevitably reveal what they know in the course of their work, according to employers.

Michigan began enforcing noncompetes in 1985. The research paper found that the ratio of mobility of inventors following the move to enforcement fell by about a third. For specialist inventors with frequently cited patents the effect was more pronounced. Marx says the findings imply that inventors and those with specialized skills should think twice before signing an extensive noncompete agreement.

Marx says: "Fundamentally, noncompetes are a form of monopoly. Just as patents permit a monopoly on a technique or tool for a limited amount of time, a noncompete (if enforced) affords a temporary monopoly of sorts on a person. The advantages of monopolies to private firms are well-documented and clearly sought after in practice."

The power of the noncompete clause
Martha Lagace
HBS Working Knowledge, February 26

Review by Joe Gill

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