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Faculty Insights

5 Things To Know About Noncompete Clauses and Constrained Employee Mobility

By Wisconsin School of Business

May 15, 2018

Martin Ganco
Martin Ganco is an associate professor in the Department of Management and Human Resources at the Wisconsin School of Business. PHOTO: PAUL L. NEWBY II

In 2016, national media broke the news that sandwich giant Jimmy John’s would no longer require its employees to sign noncompete clauses. Prior to this decision, its contracts prohibited workers from, among other things, working for sandwich competitors within a certain geographic radius for a set period post-employment.
Jimmy John’s is just one example of many companies using noncompetes, or what we refer to in our research as within-industry mobility constraints. These contracts are not just a modern phenomenon: one of my co-authors for this study, Evan Starr of the University of Maryland, has described in some of his work how early versions of today’s noncompetes existed as far back as medieval times, when apprentices trained under tradesmen.
My perspective—and what the traditional literature in general would say—is that noncompetes are constraining for employees and potentially restrict entrepreneurship and innovation because they restrict mobility. Further, some evidence suggests that companies can afford to pay lower wages if noncompetes are in place.
Martin Ganco
WSB’s Martin Ganco

In our research, my co-authors, including Evan and Benjamin Campbell of Ohio State University, and I wanted to find out whether the effects of noncompetes depend on the skill transferability of an employee across industries—something that was unique to our study and had not been used in combination before. The premise of our study was that employees who face noncompetes and have low skill transferability across industries would be effectively locked into their jobs. Taking publicly available census data from The Survey of Income and Program Participation (SIPP), we looked at measures including training, employee wages, school graduation dates, tenure in current job, occupations, and industries for 1996, 2001, 2004, and 2008. We focused on workers ages 22 to 25, employed in business and STEM for-profit occupations.
Here are five things to know about noncompetes from our study:

  1. Employees are hampered by a lack of options. Our research echoes the traditional literature that says that workers bound by noncompetes are essentially stuck; they have constrained mobility choices. What should corporations do with these employees? Invest in their professional growth. Give them training opportunities and options. This may not apply to a sandwich company employee or a warehouse worker but it might fit individuals in, for example, engineering, managerial, or top executive positions.
  2. Companies may spring for more training—if they feel safe. Let’s say I’m a company manager. I train an engineer, teach her how to program, and she leaves the firm six months later, taking her knowledge investment with her. From a company standpoint, why would I want to do that? We found that, with noncompetes in place, companies may be more likely to invest in training opportunities than they normally would because they feel safer making that financial investment.
  3. Noncompetes don’t automatically equate to savings. If corporate executives assume that using noncompetes will cut down on wage expenses, that may not be the case. What our data shows is that wages do not go down when noncompetes are instituted. Corporations may not be paying employees as much as they would under a fully competitive scenario (the absence of a noncompete), but neither are they paying these employees less—it is possible that they’re not expropriating pay from them, in other words.
  4. Noncompetes carry larger market implications. Noncompetes have the potential to change the nature of the labor market. If such clauses are in place, companies are forced to recruit individuals fresh out of school because they can’t lure more experienced workers away from competitors. Corporations, therefore, are more likely to hire inexperienced employees and new graduates and train them from the bottom up.
  5. Workers in skill-specific industries are more constrained. Certain occupations require very specific skills. If employees in these fields are saddled with noncompetes, they are doubly constrained—both within and across industries—because it’s more difficult for them to move across industries to obtain new positions. This doesn’t mean the wages are higher or lower for these individuals, just that they have less flexibility and fewer options.

In summary, noncompetes always constrain workers within industry. In no way are we defending here the use of noncompetes nor are we saying that they are inherently negative. In fact, the benefits may outweigh the costs. We deliberately stay away from making value judgements of good or bad. We believe instead that our findings offer a different perspective and should be interpreted as an additional facet of these mobility constraints, not the entire picture.
Read the paper “Strategic Human Capital Management in the Context of Cross-Industry and Within-Industry Mobility Frictions” published by Strategic Management Journal
Martin Ganco is an associate professor in the Department of Management and Human Resources at the Wisconsin School of Business.