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March 21, 2007
Asset or liability
The Conrad Black trial (see Washington Post, the WSJ and the New York Times) has drawn attention to a little publicly known but widely used intangible -- the non-compete agreement. In most cases, companies require workers to sign an agreement stating that they will not go to work for a competitor during a certain period of time. It is a way for a company to protect "its" intellectual property that resides in the skills and tacit knowledge of the workers. The concept raises interesting questions as to who really owns the IP -- the worker or the company.
It also raises questions about the transfer of knowledge. California does not enforce non-compete agreements - claiming that they are an illegal restriction of trade. The case can be made that this feature was an important part of the growth of Silicon Valley, because it allowed workers to leave one company to quickly start another. Image an alternative history where in 1957, William Shockley could have prevented 8 engineers from leaving Shockley Semiconductor to form Fairchild Semiconductor. Company hopping and spin-offs of spin-offs are a way of life in Silicon Valley - non-compete agreement literally notwithstanding.
But for the rest of the world, non-compete agreements are standard operating procedure. The Lord Black trial highlights the reverse aspect of non-competes: the non-compete payment. Payments are given to key employees to prevent them from working or setting up a competitor. Black and others are accused of fraud for arranging, without Board approval or understanding, for non-compete payments when they left the company. The prosecution likens this to extortion.
A 2004 Washington Post story on Fairchild's former CEO sheds some more light on the practice:
Noncompete payments are commonly made to employees with critical knowledge of a subsidiary's operations or customers, said John F. Olson, a corporate lawyer at the firm Gibson, Dunn & Crutcher LLP. Speaking generally, Olson said they are not typically awarded to chief executives who are primarily investors, financiers or turnaround specialists. He added that they can be used as inducements to get executives or major shareholders to go along with a deal.
"The burden of proof is really on the board to explain why that money belongs to the executives and not to Fairchild's shareholders," said Nell Minow of the Corporate Library.
John C. Coffee, a professor at Columbia Law School specializing in corporate law, said that, as a general matter, non-compete payments to chief executives or controlling shareholders when a subsidiary is sold can be a means of diverting to those individuals money that should go to all the shareholders as part of the sale price.
For those of us interested in how intangibles show up on the balance sheet, this is a good reminder that assets can be liabilities as well.
And for those of us who are interested in political economy, it is a reminder of the split between executives and workers. Workers sign non-compete agreements that require they give up certain intellectual property rights as a condition of employment; executives sign non-compete agreements requiring the company pay them for those intellectual property rights.
Very interesting.
Posted by Ken Jarboe at March 21, 2007 9:15 AM
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