Noncompete agreements (NCA) are contracts stipulating that employees cannot leave a job and work for competitors within a certain distance from the original workplace. The Federal Trade Commission (FTC) has put forward a rule, currently under public comment, that would prohibit such agreements, maintaining that their use “suppresses wages, hampers innovation, and blocks entrepreneurs from starting new businesses.”
Q: With the FTC’s newly proposed rule, noncompetes are in the news and a hot topic of discussion. President Biden referenced his desire to eliminate noncompete agreements again earlier this month in his State of the Union address. But are NCAs harmful to workers and should they really be banned?
A: It is likely that the FTC’s rule will indeed be challenged in courts given the extensive state-level legislation that exists in many states. I am speculating, but perhaps the objective of the Biden administration is primarily to influence public opinion about NCAs in each state and put a bit of pressure on Congress. Ideally, Congress would abolish NCAs at the federal level, but that is unlikely.
Firms often use the argument that NCAs preserve competition and foster innovation. The part about innovation is partially true since NCAs allow firms to better retain investments in people and knowledge assets. However, the existing research implies that the costs in terms of the loss of valuable expertise that mobile employees bring into their new workplaces, fewer startups, loss of dynamism in the labor market, and the social costs outweigh the benefits to incumbent firms. Consumers and workers clearly benefit from a labor market without NCAs.
Strategic management literature has traditionally conceptualized restrictive legal levers like NCAs as being of considerable benefit to firms, an advantage they will wield more often than not. But in an interesting twist, findings from one of my recent studies suggest that some firms willingly opt out of NCA use as a way to attract talented workers. In this case, we find that NCA bypassing is happening with firms that are not necessarily the leaders in their respective industries; rather they are companies that depend heavily on talent to differentiate from their competitors. So, it’s a bit of a departure from how we are used to thinking about the use of these restrictive practices among firms and within the labor market.
—Martin Ganco is the Robert Pricer Chair in Enterprise Development and a professor in the Department of Management and Human Resources at the Wisconsin School of Business. He is the academic director of the Weinert Center for Entrepreneurship.
Read the working paper: “Strategic Restraint: Why Companies Do Not Use Noncompete Agreements When They Can?”