Are non-compete agreements bad for innovation?

| 1 Comment

Non-compete agreements are a standard mechanism that companies use to try to protect what they see as their intellectual property. They are so standard that they are recognized by the accountants as an intangible asset. Yet, the question remains whether they are effective and enforceable. As I noted in Intangible Asset Monetization, non-compete agreements are considered illegal under California's Business and Professions Code Section 16600 as a restraint of commerce. A number of other states also tend not to enforce non-compete agreements or limit their scope. For example, last November the Virginia Supreme Court once again ruled that an overly broad non-compete agreement could not be enforced (see earlier posting).

But the real question is whether such restrictions can harm innovation. The standard counter-argument to non-compete agreement is Silicon Valley. Many have argued that the lack of such restrictions on the free flow of information and people is a hallmark of the Valley's innovative culture.

Recent work by Matt Max of MIT and his colleagues describe a different problem: the impact on human capital. In one study, they found that enforcement of non-compete agreements drives away inventors to locations that do not enforce these agreements (see "Regional Disadvantage? Non-compete Agreements and Brain Drain". Another study shows that non-compete agreements waste human capitol by forcing knowledge workers to switch fields, thereby losing the ability to utilize their existing skills and knowledge base (see "Non-compete agreements create 'career detours".)

The issue is beginning to get more attention in policy circles. For example, the Kauffman Foundation's new report StartUp Act for the States specifically mentions the problem of non-compete agreements restricting labor mobility and cites the work done by Professor Marx and others. While not calling for the elimination of non-compete agreements, the report lays the case for why a state might want to relax enforcement:

What we recommend is that each state look hard at its legislative policy and judicial doctrine on the matter and make a calculated decision as to whether lax or vigorous enforcement will better serve its objectives. If a state seeks to promote higher entry by new businesses and help them hire and grow, then perhaps more relaxed enforcement is called for. If a state seeks to bolster the economic health of its existing businesses--perhaps because the state's economy relies heavily on sectors with larger and older companies--then non-compete enforcement might remain appropriate policy.
This was elaborated on in response to a question I asked during panel discussion at the Kauffman State of Entrepreneurship event - see video at 38:00 minute. In that answer Bob Litan of Kauffman made it very clear that there are other ways to protect intellectual property - specifically through trade secrets.

It seems to me that the trade secret route could be a much more effective mechanism. It would be interesting to see work on the application of trade secrets in places like California and Colorado where non-compete agreements are not allowed. The problem is that maintaining trade secrets is more difficult and takes more work on the part of the company. I wonder if companies simply default to the easier action of using non-compete agreements. If that is the case, then the restriction or elimination of non-compete agreements might force greater attention to trade secrets.

Given this new attention - and the availability of alternatives, I would not be surprised to see at least some states begin to take a hard look at their position on non-compete agreements.

1 Comment

I often see over-reliance on non-competes as a substitute for understanding intangible capital. The assumption is that the most valuable knowledge in an organization is inside peoples' heads.

This especially happens in M&A when the acquirer assumes that the key assets they are buying are the people, the customer list and the products. But process, knowledge and data are often as or more important than these obvious assets. And failure to document and understand these assets as trade secrets or even as work methods leaves the acquirer vulnerable to the very risk they could have avoided--key people walking out the door after their non-compete expires.

You can't protect a trade secret if you don't understand it as such. To decrease the reliance on non-competes it will first be necessary to increase corporate understanding of intangible capital.

Leave a comment

    Note: the views expressed here are solely those of the author and do not necessarily represent those of Athena Alliance.


Creative Commons License
This blog is licensed under a Creative Commons License.
OpenID accepted here Learn more about OpenID
Powered by Movable Type 5.12