Office of Economic Policy
U.S. Department of the Treasury
Non-compete Contracts: Economic Effects and Policy
Implications
March 2016
2
Table of Contents
Executive Summary .................................................................................................................................... 3
Section I. Non-competes and Their Justifications ................................................................................... 6
Section II. What Can We Say About the Justifications? ...................................................................... 11
Section III. The Details of Non-compete Enforcement ......................................................................... 14
Section IV. Effects of Non-compete Enforcement ................................................................................. 18
Section V. Directions for Reform ............................................................................................................ 24
Appendix A ............................................................................................................................................... 27
Appendix B ............................................................................................................................................... 32
Works Cited .............................................................................................................................................. 34
3
Executive Summary
Non-compete agreements are contracts between workers and firms that delay employees’ ability
to work for competing firms. Employers use these agreements for a variety of reasons: they can
protect trade secrets, reduce labor turnover, impose costs on competing firms, and improve
employer leverage in future negotiations with workers. However, many of these benefits come
at the expense of workers and the broader economy. Recent research suggests that a
considerable number of American workers (18 percent of all workers, or nearly 30 million
people) are covered by non-compete agreements.
1
The prevalence of such agreements raises
important questions about how they affect worker welfare, job mobility, business dynamics, and
economic growth more generally. This report presents insights from economic theory and
evidence on the economic effects of non-compete agreements. It goes on to discuss policy
implications, starting a discussion about how such agreements could be used in a way that
balances the interests of firms with those of workers and society as a whole.
Non-compete agreements have social benefits in some situations.
• Non-competes are sometimes used to protect trade secrets, which can promote
innovation.
• By reducing the probability of worker exit, non-competes may increase employers’
incentives to provide costly training.
• Employers with especially high turnover costs could use non-competes to match with
workers who have a low desire to switch jobs in the future.
But non-compete agreements can also impose large costs on workers.
• Worker bargaining power is reduced after a non-compete is signed, possibly leading to
lower wages.
• Non-competes sometimes induce workers to leave their occupations entirely, foregoing
accumulated training and experience in their fields.
1
These and other similar numbers throughout the executive summary and report are from Starr, Bishara, and
Prescott (2015) and private correspondence with the authors. Note that all figures are preliminary and may change
slightly.
4
• Reduced job churn caused by non-competes is itself a concern for the U.S. economy. Job
churn helps to raise labor productivity by achieving a better matching of workers and
firms, and may facilitate the development of industrial clusters like Silicon Valley.
Moreover, there is reason to believe that many specific instances of non-compete
agreements are less likely to produce social benefits.
• Non-competes are often used by employers in non-transparent ways:
o Many workers do not realize when they accept a job that they have signed a non-
compete, or they do not understand its implications.
o Many workers are asked to sign a non-compete only after accepting a job offer.
One lower-bound estimate is that 37 percent of workers are in this position.
o Many firms ask workers to sign non-competes that are entirely or partly
unenforceable in certain jurisdictions, suggesting that firms may be relying on a
lack of worker knowledge. For instance, California workers are bound by non-
competes at a rate slightly higher than the national average (19 percent), despite
the fact that, with limited exceptions, non-competes are not enforced in that state.
2
• Only 24 percent of workers report that they possess trade secrets. Moreover, less than
half of workers who have non-competes also report possessing trade secrets, suggesting
that trade secrets cannot explain the majority of non-compete activity.
• Non-competes are common among workers who report lower rates of trade secret
possession: 15 percent of workers without a four-year college degree are subject to non-
competes, and 14 percent of workers earning less than $40,000 have non-competes. This
is true even though workers without four-year degrees are half as likely to possess trade
secrets as those with four-year degrees, and workers earning less than $40,000 possess
trade secrets at less than half the rate of their higher-earning counterparts.
• Available evidence suggests that workers with a low initial desire to switch jobs are not
more likely to match with employers who require non-competes.
• In some cases, non-competes prevent workers from finding new employment even after
being fired without cause; in such cases, it is difficult to believe that non-competes yield
social benefits.
2
Depending on the facts of the individual case, such non-competes may be enforced in other states.
5
States vary greatly in the manner and degree to which they will enforce non-competes.
• In some states, non-compete enforcement is determined by statute, while in others it is
determined exclusively by case law.
• Some states refuse to enforce non-competes, or refuse to enforce non-competes that
contain any unenforceable provisions (“red-pencil” doctrine), although a majority of
states will modify overbroad non-compete contracts to render them enforceable (“blue-
pencil” and “equitable reform” doctrines).
The analysis in this report suggests several broad recommendations that would minimize
the harms associated with non-compete agreements.
• Increase transparency in the offering of non-competes.
• Encourage employers to use enforceable non-compete contracts.
• Require that firms provide “consideration” to workers bound by non-compete contracts in
exchange for both signing and abiding by non-competes.
6
I. Non-competes and Their Justifications
3
Non-compete contracts – agreements between workers and firms that restrict workers’ ability to
take new employment – have a long history, but their scope, prevalence, and enforcement have
varied widely across time and place. With the recent development of more comprehensive data
on their usage, it has become more apparent that non-competes are an important labor market
institution meriting careful study. Recent research shows that as many as 30 million workers are
currently covered by non-compete agreements. While in some cases non-compete agreements
can promote innovation, their misuse can benefit firms at the expense of workers and the broader
economy. Details of non-competes and their enforcement have implications for worker
bargaining power, job mobility, and economic growth. This report draws on insights from
economic theory, as well as a rapidly growing body of empirical evidence, to help clarify
thinking about non-competes and non-compete reform.
What are non-competes and who is bound by them?
Many employers ask their employees to sign non-compete agreements. The details of these
contracts vary greatly across firms and states, but they share a common purpose: restricting the
ability of a worker to compete with his or her current employer for some specified period of
time, often in a specified geographic area. Typically, this takes the form of a prohibition on
taking employment at a rival firm, where “rival” may be interpreted quite broadly to include all
firms within a given industry.
Non-compete agreements have become quite common among a variety of types of workers. As
shown in the chart below, roughly 18 percent of workers currently report working under a non-
compete agreement and about 37 percent of workers report having worked under one at some
point during their career. Although such agreements are less common among less-educated
workers and lower-income workers, the fractions of these workers operating under one are still
substantial.
4
3
This report benefited greatly from discussions with Professor Evan Starr, and we are grateful for his time and
expertise. We also make extensive use of Starr, Bishara, and Prescott (2015). However, the views expressed here
are not necessarily those of Starr and his coauthors, nor are they implicated in any errors.
4
See Starr, Bishara, and Prescott (2015).
7
How are non-competes typically justified?
The conventional picture of a workplace characterized by non-compete agreements is one that
features trade secrets, including sophisticated technical information and business practices that
firms have a strong interest in protecting. By preventing a worker from taking such secrets to a
firm’s competitors, the non-compete essentially solves a “hold-up” problem: ex ante, both
worker and firm have an interest in sharing vital information, as this raises the worker’s
productivity. But ex post, the worker has an incentive to threaten the firm with divulgence of the
information, raising his or her compensation by some amount equal to or less than the firm’s
valuation of the information. Predicting this state of affairs, the firm is unwilling to share the
information in the first place unless it has some legal recourse like a non-compete contract.
Occasionally, client relationships are included along with trade secrets in this explanation (and
are sometimes treated similarly as a matter of state law). However, it is not clear that
relationships with clients constitute a socially valuable investment analogous to trade secrets.
5
For this reason, trade secrets will be the focus of discussion in this report.
5
For instance, a trade secret involving intellectual property may be the product of expensive investments. If the
investment had not been made, none of the benefits of the property would have been realized. By contrast, the
8
While non-competes help solve the trade secrets “hold-up” problem, they are not the only tool at
employers’ disposal. States generally have laws prohibiting theft or disclosure of trade secrets.
In addition, employers can use compensation schemes that discourage turnover for workers with
trade secret access (e.g., employers may provide additional compensation contingent on the
worker remaining at the firm).
6
We provide further evidence regarding trade secrets later in the
report.
What are other possible explanations?
What might explain the existence of non-competes among workers who are not plausibly
affected by the sort of trade secrets discussed previously? A number of explanations have been
suggested. One possibility (training) – which may coexist with either of the next two
explanations – is that firms and workers use non-competes to encourage more investment in
workers. In general, firms are reluctant to pay for training that improves a worker’s “general”
skills and makes her more valuable to it and other firms alike. Economists usually think of
general training as occurring when workers accept wage cuts to compensate their employer for
its expenses in providing the training.
7
For various practical reasons, however, workers may be
unwilling to pay for training.
8
Non-competes offer an alternative: firms get an assurance that
workers are unlikely to leave for some period of time, allowing the firm to capture more of the
increased productivity from costly training it provides, and workers receive more training than
they otherwise would.
Another possibility (screening) is that non-competes are an attempt by firms to preferentially
hire workers with a low likelihood of departure. Underlying this alternative is the assumption
that firms face substantial costs for hiring and separating with workers.
9
Moreover, it is not
obvious to firms which workers are most likely to exit, and workers cannot credibly assert their
probability of leaving (i.e., all workers will pretend to have a very low probability, as this raises
their perceived value to the firm). By making non-competes a condition of employment, firms
client, and their need for a good or service, presumably exist independently of any investment made by the
employer.
6
See Salop and Salop (1976) for one discussion of such a mechanism.
7
See Becker (1962).
8
For instance, workers may be credit-constrained and unable to finance the training, or workers may have difficulty
observing the quality of the training, rendering them less willing to pay for it.
9
See Hamermesh (1995).
9
reduce the value of the job to those workers who know they are likely to depart. For those
workers who do not expect to leave imminently, the non-compete is less of an imposition. Note
that in order for this explanation to be correct, prospective workers must understand the non-
compete and its implications.
A final explanation (henceforth referred to as lack of salience) is that workers do not pay
attention to non-compete contracts and do not realize how much bargaining power and future
employment flexibility they are foregoing. Only later, when workers consider exiting a firm, do
they become aware of the existence and/or implications of the non-compete agreement.
10
Other
workers may be aware of the non-compete, but only after it is presented to them once they have
accepted a position or started working, and not at the time the job offer was originally extended.
According to this explanation, only employers benefit from the non-compete, as they obtain
increased bargaining power in future wage negotiations, reduced turnover costs, and possible
impairment of rivals’ ability to hire.
How do the different non-compete explanations affect the optimal policy response?
The explanations for non-compete agreements described above have different implications for
the desirability of such agreements. Thinking through these implications helps to shed light on
the appropriate policy response. The first three explanations – trade secrets, training, and
screening – suggest that non-competes can be socially desirable. The last explanation, lack of
salience, suggests that non-competes are socially harmful.
The conventional explanation for non-compete agreements involving protection of trade secrets
is a potentially strong justification for such agreements where it genuinely applies, and where
other devices for protection of employers (like trade secrets law) are not effective. As previously
discussed, non-competes can encourage additional economic activity and broader information
sharing when trade secrets are significant.
The training and screening explanations for non-compete agreements also suggest social
benefits. If worker training is sufficiently enhanced by the availability of non-competes, or if
10
Research in other contexts has found a large role for salience considerations. See Kahneman (2003) for a
discussion of salience as it relates to behavioral economics, and Feldman, Katuscak, and Kawano (2016) for an
example from the tax literature.
10
firms with unusually high separation costs are able to match more appropriately with workers,
both worker and firm are better off. Balanced against these benefits are the social costs
associated with diminished mobility.
The final explanation for non-compete agreements – lack of salience – implies that non-
competes are merely a costly transfer from workers to firms, made possible by workers’ lack of
awareness. According to this explanation, non-competes lead to diminished worker mobility and
a loss of human capital, with no corresponding benefit to society. When workers are legally
prevented from accepting competitors’ offers, those workers have less leverage in wage
negotiations and fewer opportunities to develop their careers outside of their current firm. By
contrast, the firms using non-competes benefit through reduced turnover costs, increased
bargaining power, and denial of valuable employees to competitors.
Constructing ideal policy for non-competes requires determining which explanation is most
relevant for a particular type of worker (i.e., for low-skill service workers vs. high-skill IT
workers), and balancing the trade-offs between non-competes’ benefits and their undesirable
consequences. For instance, low-wage workers may be particularly poorly served by non-
competes due to the lower likelihood that trade secrets are relevant.
However, it is not always easy to distinguish among the different explanations for non-competes,
and several possible reforms are beneficial regardless of the underlying explanation. For
example, measures to improve the salience and transparency of non-competes and non-compete
enforceability are broadly useful and will help to minimize the worst effects of non-competes.
In Section V, some directions for policy reform are described and their reasoning briefly
explained.
11
II. What Can We Say About the Justifications?
Research on non-competes is still at an early stage. However, a recent paper provides
comprehensive data on workers with non-competes, answering many of the most important
questions about these workers.
11
In addition to collecting information on the characteristics of
workers who sign non-competes, this research also examines the extent to which workers with
non-competes actually interact with clients, have access to client-specific information, and work
with trade secrets.
12
This section summarizes the literature examining the different rationales for
non-compete agreements.
Protecting trade secrets. If protection of trade secrets were the main explanation for non-
compete agreements, then one would expect such agreements to be highly concentrated among
workers with advanced education and occupations likely to feature trade secrets.
13,14
However,
the fraction of workers without a four-year college degree reporting a current non-compete
agreement is about 15 percent, only slightly below the 18 percent share for all workers.
15
While
engineering and computer/mathematical occupations have the highest non-compete prevalence at
slightly more than one-third, occupations like personal services and installation and repair also
include many workers with non-competes, at about 18 percent. When entry-level workers at fast
food restaurants are asked to sign two-year non-competes, it becomes less plausible that trade
secrets are always the primary motivation for such agreements.
16
Unsurprisingly, workers who reported access to trade secrets were much more likely to be bound
by a non-compete, with about a 25 percentage point higher probability than those who report no
interaction with clients, no access to client-specific information, and no possession of trade
secrets. The link between client access and non-competes is not as strong: those who report such
11
See Starr, Bishara, and Prescott (2015).
12
As the authors’ data is collected through an online survey, achieving a representative sample may be challenging.
The authors note, however, that more traditional survey designs face similar difficulties.
13
Note that not all trade secrets are equivalent from an economic perspective. Though the legal definition of trade
secrets embraces a wide variety of private information (e.g., fast-food recipes), some of these examples may not
involve a substantial “hold-up” problem of the kind described above.
14
See Starr, Bishara, and Prescott (2015) for evidence that occupations and income groups differ substantially in the
degree to which they involve trade secrets.
15
See Starr, Bishara, and Prescott (2015).
16
See http://www.forbes.com/sites/clareoconnor/2014/10/15/does-jimmy-johns-non-compete-clause-for-sandwich-
makers-have-legal-legs/.
12
access (but no trade secrets) have about a 7 percentage point higher probability of a non-
compete. However, less than half of all workers with non-competes report possessing trade
secrets. Together, these findings suggest that the trade secrets explanation is likely part, but not
all, of the story of non-competes.
Encouraging training. Non-compete enforcement is associated with more worker training. Evan
Starr finds that a “one standard deviation increase in a state’s overall enforceability level
increases the probability that the average high litigation occupation receives firm-sponsored
training by 2.4% relative to low litigation occupations.”
17
Interestingly, this work finds that
when states require firms to offer substantial “consideration” along with a non-compete (e.g.,
promotions, training, and higher wages), both training and wage outcomes for workers are
improved.
Facilitating screening. Starr, Bishara, and Prescott have developed data that are directly relevant
to the question of screening by asking their survey respondents how long they expected to work
for their current employer, then comparing the responses of workers who have and have not
signed non-competes. Interestingly, after controlling for various demographic and economic
variables, there is no relationship between expected tenure and likelihood of having signed a
non-compete. This result suggests that screening is not an important part of the non-compete
story.
Exploiting lack of salience. Several pieces of evidence suggest that employers are relying on
workers’ incomplete understanding of non-compete agreements. First, employers often require
that workers sign non-compete agreements even in states that refuse to enforce them. For
example, in California, which (with limited exceptions) does not enforce non-compete
agreements, the fraction of workers currently under a non-compete is 19 percent, which is
slightly higher than the national average.
Second, a separate survey, exclusively focused on members of the Institute of Electrical and
Electronics Engineers, reports that “…barely 3 in 10 workers reported that they were told about
the non-compete in their job offer. In nearly 70% of cases, the worker was asked to sign the
17
See Starr (2015), page 3. “Enforceability level” is defined by Starr to capture all the dimensions of non-compete
enforcement, and “high-litigation” refers to occupations characterized by more legal action related to non-compete
contracts.
13
non-compete after accepting the offer – and, consequently, after having turned down (all) other
offers. Nearly half the time, the non-compete was not presented to employees until or after the
first day at work.”
18
This evidence is especially powerful insofar as it applies to highly-
educated, high-wage workers who might be considered more likely to understand the process
surrounding non-competes. Even in cases where the conventional explanation of trade secrets
has a surface plausibility, firms often delay the presentation of non-competes. This behavior
would not be necessary if non-competes were a mutually-beneficial arrangement.
Finally, Starr, Bishara, and Prescott (2015) find that only 10 percent of workers with non-
competes report bargaining over their non-compete, with 38 percent of the non-bargainers not
realizing that they could even negotiate.
19
Moreover, workers appear confused as to whether
non-competes are even enforceable in their states. In preliminary work by Starr and coauthors,
workers are shown to be frequently incorrect or unsure as to whether their non-competes are
actually enforceable. Again, this is not consistent with a “perfect information” setting in which
workers knowingly accepted the limitations imposed by non-competes.
18
See Marx and Fleming (2012), page 49.
19
See Starr, Bishara, and Prescott (2015).
14
III. The Details of Non-compete Enforcement
Non-compete enforcement differs significantly across states. Some relevant terms of art are
defined below.
Non-compete contract: A contract that delays or in some other way restricts a
worker’s ability to compete with a previous employer. Typically this entails restrictions on
future employment.
Consideration: A benefit received by a signatory to a contract. Generally, both
parties must receive consideration in order for a contract to be valid. Consideration commonly
includes property or promises of specific actions. In the case of a non-compete, consideration
may sometimes refer to wage increases, promotions, or continued employment (sometimes
including hiring).
Protectable interests: These are the aspects of an employer-employee
relationship that provide the legal motivation for a non-compete agreement. They vary state to
state, but frequently include trade secrets, confidential information, goodwill, and/or client
relationships. Some states additionally provide protection for special training.
Red-pencil doctrine: Doctrine prevailing in some states requiring that courts
must declare an entire non-compete contract void if one or more of its provisions are found to be
defective under state law or precedent.
Blue-pencil doctrine: Doctrine prevailing in some states requiring that courts
delete provisions of a non-compete contract that render it overbroad or otherwise defective,
retaining the enforceable subset of the contract.
Equitable reform, aka Reformation: Doctrine prevailing in some states
requiring that courts may rewrite a non-compete contract so as to render it non-defective. Unlike
blue-pencil doctrine, this may entail insertions of new text.
15
Currently, nearly all states will enforce non-compete agreements to some extent. Within those
states, non-compete enforcement may be restricted in a variety of ways that vary from state to
state. See Beck Reed Riden LLP for a summary of state rules.
20
Judicial modification of non-competes. Rather than declaring specific contracts completely
enforceable or unenforceable, courts in certain states may alter the contracts themselves. In
those states, judges may declare portions of a contract void but other parts to be valid under what
is called “blue pencil doctrine.”
The following stylized example may help to explain how this doctrine might work. Suppose that
a contract states that “The employee agrees not to work for any business competitive with the
employer for one year in the following counties: Leelanau, Benzie, and Manistee.” Purely
hypothetically, a judge might find the inclusion of Benzie to be overbroad, and could determine
that the non-compete is valid once Benzie County is removed. However, as blue-pencil doctrine
does not allow a court to add terms to a contract, the contract could not be revised to add “agrees
not to work in an administrative capacity”, were the court to hold that this qualifier was
necessary to prevent the contract from being overbroad.
In other states, an “equitable reform” or “reformation” doctrine allows judges to amend the
language in question to generate an enforceable contract consistent with the original intent of the
existing contract.
21
This allows more flexibility than the blue pencil rule and increases the
likelihood of a non-compete being upheld in some form, all else equal. It may also encourage
firms to take risks in the writing of contracts, including provisions likely to be struck down. If
workers do not have a good sense of which parts of a contract are enforceable, then these
untenable provisions may still affect their behavior. On the opposite end of the spectrum, some
states simply do not allow any judicial modification of contracts, but instead hold that any
unenforceable provisions render the entire contract unenforceable. This is sometimes known as
“red-pencil” doctrine.
20
Other summaries of non-compete law exist and are in some cases slightly inconsistent with the Beck Reed Riden
table we use; see “Summary of Covenants Not to Compete: A Global Perspective
” by Fenwick and West LLP, for
one alternative.
21
In some cases, this doctrine is (confusingly) also referred to as “blue-pencil.”
16
The figure below illustrates findings by one survey of the use of each rule by state.
22
See
Appendix B for additional figures illustrating the survey’s findings regarding other important
dimensions of non-compete enforcement, including treatment of trade secrets, enforceability in
case of firing without cause, and whether “continued employment” counts as worker
consideration in exchange for a non-compete.
Quits vs. Layoffs. The paradigmatic case of non-compete enforcement is one in which an
employee quits and is prevented from working for a competitor. However, even fired workers
are often bound by non-compete contracts. One survey reports that, as of 2015, non-competes
were enforceable against employees discharged without cause in about half of states.
23
Recent changes in non-compete enforcement. Several states have recently altered their
approaches to non-compete enforcement. Notably, Georgia amended its constitution in 2011 to
allow for increased enforcement of non-compete agreements.
24
Other states have altered their
statutes to extend or limit the reaches of non-competes, as with a recent statute in Alabama that
more explicitly explains what is and is not a valid protectable interest. Like Alabama, Oregon
passed a statute that more clearly defines the bounds of a non-compete. As of 2016, new non-
competes in Oregon will be limited to a maximum of 18-month duration. New Mexico also
22
Alaska and Hawaii, not shown, are both “reformation” states.
23
See Beck Reed Riden LLP (2015).
24
See http://www.lexology.com/library/detail.aspx?g=aadbea62-9a31-4ae3-92dd-8198906c37f6.
Not enforced
Undecided
Red pencil
Blue pencil
Reformation
Source: A State by State Survey of Employee Noncompetes, Beck Reed Riden
Non-compete Enforcement Regime
17
more clearly defined the bounds of non-competes, restricting their enforceability for certain
health care practitioners. In Hawaii, non-competes have been prohibited for tech workers.
25
In other states, legislators have recently proposed significant changes. A bill similar to that
passed in Hawaii was introduced, but not enacted, in Missouri. In New Jersey and Maryland,
bills were proposed that would render non-competes unenforceable for any workers eligible to
receive unemployment compensation. State legislators in Massachusetts, Michigan, and
Washington have proposed that non-competes be made largely unenforceable in their states.
Finally, Senators Franken and Murphy have proposed that firms be prohibited from entering into
non-compete agreements with workers making less than $15 per hour.
26
Appendix A provides a brief summary of the development of non-compete law over the long run.
25
See https://legiscan.com/AL/bill/HB352/2015, http://gov.oregonlive.com/bill/2015/HB3236/,
http://www.nmlegis.gov/lcs/legislation.aspx?chamber=S&legtype=B&legno=325&year=15, and
http://www.capitol.hawaii.gov/session2015/bills/HB1090_CD1_.HTM, for Alabama, Oregon, New Mexico, and
Hawaii law, respectively.
26
Private correspondence with Evan Starr. See
http://house.mo.gov/billtracking/bills151/billpdf/intro/HB0597I.PDF
,
http://www.njleg.state.nj.us/2012/Bills/A4000/3970_I1.HTM,
http://mgaleg.maryland.gov/2013RS/fnotes/bil_0001/sb0051.pdf, https://malegislature.gov/Bills/189/House/H1701,
http://www.legislature.mi.gov/(S(eemdorjddeyzki1vwou5lszu))/mileg.aspx?page=GetObject&objectName=2015-
HB-4198, http://app.leg.wa.gov/billinfo/summary.aspx?year=2015&bill=2931, for Missouri, New Jersey, Maryland,
Massachusetts, Michigan, and Washington, respectively. See
http://www.franken.senate.gov/files/documents/150604MOVEsummary.pdf for the proposed federal bill.
18
IV. Effects of Non-compete Enforcement
The effects of non-compete enforcement on mobility. According to authors of a recent study, the
state of Michigan inadvertently “legalized” non-competes in 1985.
27
This presented a rarely
available opportunity to study the effect of non-compete enforcement. Typically, it is difficult to
rule out the possibility that changes in law reflect changes in current or expected economic
circumstances. Thus, a simple comparison of economic outcomes before and after a state
legalizes non-competes will include the effects of both these changes in circumstances and non-
compete enforcement itself, making it difficult to separately estimate the latter effect. But in the
case of Michigan, with its allegedly accidental and unanticipated change in the enforceability of
non-competes, researchers can more reliably interpret changes in outcomes (e.g., labor mobility)
as being caused by non-compete enforcement.
Marx, Strumsky, and Fleming exploit this natural experiment, showing that worker job mobility
fell by 8 percent when non-competes were made enforceable, with the effect even larger for
workers with more narrowly-focused human capital. However, other authors dispute these
findings, arguing that the inadvertent legalization was not retroactive and that some states were
inappropriately labeled as “non-enforcing.”
28
In separate work, Marx finds that workers who do
switch jobs are more likely to leave their industry if they are covered by a non-compete, with the
attendant “reduced compensation, atrophy of their skills, and estrangement from their
professional networks” that would be expected to occur.
29
The effects of non-compete enforcement on wages. The literature on the effect of non-competes
on wages is small, consisting largely of case studies, surveys of specific professions (e.g.,
electrical engineers), theoretical papers, and a recent analysis based on a broad online survey.
30
We therefore combine information from previous literature on enforceability and non-compete
prevalence with standard labor market data, generating suggestive evidence on the wage impacts
27
See Marx and Fleming (2012) for details.
28
See Sichelman and Barnett (2015).
29
See Marx, Strumsky, and Fleming (2009) and Marx (2011).
30
See various papers by Marx, Marx and Fleming (2012), Meccheri (2009), and Starr, Bishara, and Prescott (2015),
respectively. We are not aware of any panel data with individual responses to questions about non-competes, and
existing work typically does not present population-wide inferences about the wage effects of non-compete
enforcement.
19
of non-compete enforcement.
31
Interestingly, we find stricter non-compete enforcement to be
associated with both lower wage growth and lower initial wages.
32
The first column of Table 1 shows the percentage change in wages from a one-unit increase in a
non-compete enforceability index, holding constant a number of worker characteristics.
33
It
suggests that a standard deviation in non-compete enforcement reduces wages by about 1.4
percent. Recent work by Starr and coauthors finds broadly similar results to those presented
here.
34
It is possible to refine this approach by focusing more narrowly on populations likely to be
affected by non-competes. Workers with bachelor's degrees are more than 50 percent more
likely to be bound by non-competes than those without, suggesting that one might better
approximate the “eligible” subgroup by restricting the sample to workers with bachelor's
degrees. This is shown in Table 1, column 2. Note that the magnitude of the wage effect of non-
compete enforcement increases for this subgroup, as expected. A slightly more nuanced
approach makes use of the occupational breakdown provided in recent work. Rather than
omitting non-college workers, we instead reweight the sample to be more representative of
workers with non-competes. For example, this will imply placing a higher weight on workers in
the architecture and engineering occupations than in the personal services occupations. Table 1,
column 3 shows results from this reweighted approach. The magnitude of the wage impact is
again above that of column 1, but not dramatically so.
35
31
We use the 2014 merged outgoing rotation groups of the Current Population Survey (CPS), which provide a cross
section of population-representative workers. Merged with this data is the Starr-Bishara index of non-compete
enforceability by state (generously provided by Evan Starr), as well as the fraction of workers with non-competes by
major occupation from Starr, Bishara, and Prescott (2015).
32
Here again, the particular proposed explanation for non-competes is important. For instance, if screening is the
dominant explanation, and workers are fully informed about non-competes, we would expect stricter enforcement to
cause an initial wage premium but slower subsequent wage growth. Workers would only be willing to sign the non-
compete if they were compensated at the time of signing. If, on the other hand, salience is the dominant
explanation, we would expect no initial premium and slower wage growth, as workers are prevented from taking
advantage of outside opportunities or using outside opportunities as leverage for wage growth at the current firm.
33
These controls consist of education, age, gender, marital status, occupation, industry, public sector status, and
union status.
34
See forthcoming work by Balasubramanian, Chang, Sakakibara, Sivadasan, and Starr, as well as Starr, Ganco, and
Campbell.
35
This is perhaps to be expected given the fact that that non-competes are used quite broadly. While non-competes
are more common in particular occupations (e.g., management, computer and mathematical, and architectural and
engineering occupations), they are also found in a wide variety of unexpected occupations and education levels.
20
Much of the research on non-competes has focused on their relationship with on-the-job training.
Non-competes and non-compete enforceability may affect the rate at which wages grow with
employee tenure and experience. We therefore examine the association of non-compete
enforceability with age-wage profiles, i.e., the rate at which wages increase with age.
Figures 1 and 2 below are plots of age-wage profiles in a minimally-enforcing state and a
maximally-enforcing state, for original and occupation-reweighted samples, respectively. As
workers age, the effect of tightened non-compete enforcement appears to rise: using the original
sample, the effect of maximal enforcement, relative to minimal enforcement, is 5 percent at age
25 and 10 percent at age 50. As with the previous results, the occupation-reweighted projections
show a somewhat larger difference between wages in minimally- and maximally-enforcing
states.
Are these results surprising? If non-competes existed exclusively to promote training, one would
expect states with stronger enforcement to see faster wage growth over the life cycle. If, on the
other hand, non-competes are the product of a lack of salience for workers, one would instead
expect to see the pattern shown in Figures 1 and 2.
36
As workers progress through their careers,
switching jobs is more difficult in states that stringently enforce non-competes. Given that job
36
When interpreting any of the results just described, it should be remembered that we are not exploiting variation
over time in non-compete enforcement; rather, the wage estimates are derived from variation across states. Even
after controlling for available worker-level variables, states may differ in ways that are both relevant to wage growth
and non-compete enforcement. As such, the results shown here should be seen as merely suggestive.
Source: 2014 Current Population Survey, Starr et al. (2015), private correspondence with Starr, and Treasury calculations. All
estimates are conditional on education, marital status, union status, sex, major occupation and industry, public sector status, and a
quadratic in age. T-statistics are in parentheses.
Table 1. Wage effect of one standard deviation of noncompete enforcement
21
switching is generally associated with substantial wage increases, this increased difficulty of
switching would reduce wage growth over time.
37
37
See Topel and Ward (1992).
12 14
16 18
20 22
24
Hourly wage
20
30
40
50
60
Age
No enforcement Max enforcement
Source: 2014 Current Population Survey, Starr et al. (2015), and Treasury calculations. All
variables, with the exception of enforcement index and age, are held constant at their means.
Original sample
Figure 1. Age-Wage Profile by State Enforcement Regime
12 14 16 18 20 22 24
Hourly wage
20 30 40 50 60
Age
No enforcement Max enforcement
Source: 2014 Current Population Survey, Starr et al. (2015), and Treasury calculations. All
variables, with the exception of enforcement index and age, are held constant at their means.
Occupation-reweighted
Figure 2. Age-Wage Profile by State Enforcement Regime
22
Non-compete enforcement and aggregate impacts. Thus far, we have discussed the effects of
non-competes on individual workers. But non-compete enforcement may matter for cities,
states, and regions in ways that cannot be fully understood at the individual level. Whether non-
competes are beneficial or harmful for a single worker and a single firm, there are potential
spillovers across workers and firms, particularly related to information.
In urban economics, regions are subject to so-called “agglomeration effects.” For instance, high-
tech firms do not locate randomly, but tend to cluster in places like Silicon Valley. This
clustering is due to a number of factors that include the availability of a large, deep pool of
workers with relevant skills, a more competitive market of suppliers, and information spillovers
across workers and firms. This last factor is important in connection with non-competes. When
firms in a given industry are clustered, it becomes easier for their workers to share expertise and
discoveries. While not always in the interest of a particular firm, this sharing can redound to the
advantage of the larger economy, making the cluster an attractive destination for firms.
One important facilitator of this sharing is, unsurprisingly, the movement of workers across firms
within industry. Employee departures impose costs on their firms, but yield benefits for
destination firms and act to broadly disseminate improvements in technologies and best
practices. Non-compete enforcement can stifle this mobility, thereby limiting the process that
leads to agglomeration economies.
Many observers have suggested that Silicon Valley is a prime example of this phenomenon.
38
California, along with some other states, generally does not enforce non-compete agreements. It
would be difficult to reach definitive conclusions about one instance of an industrial cluster, of
course. One fact contradicting the hypothesis of free mobility is that high-tech firms in Silicon
Valley have been alleged to collude to suppress wages and reduce “poaching.”
39
We do not
know precisely how this behavior interacts with use of non-competes; in other words, the
California firms may have been colluding as a substitute for using non-competes. Nevertheless,
the Silicon Valley example highlights the importance of information sharing facilitated by
worker mobility in some industrial clusters.
38
For example, see Gilson (1999).
39
See http://www.wsj.com/articles/judge-rejects-settlement-in-silicon-valley-wage-case-1407528633.
23
Singh and Marx look more broadly at informational spillovers and find that non-compete
enforcement reduces their scope. Furthermore, using the Michigan natural experiment and cross-
sectional data, Marx, Singh, and Fleming find that highly skilled workers tend to move from
enforcing to non-enforcing states. This suggests that non-competes play a role in “brain drain,”
potentially harming states that enforce non-competes more stringently.
40
Samila and Sorenson (2011) also examine the relationship between non-compete enforcement
and regional employment and entrepreneurship. They find that more stringent enforcement is
negatively related to both employment growth and entrepreneurship, consistent with results from
Marx and coauthors.
40
See Singh and Marx (2011) and Marx, Singh, and Fleming (2011). Note that this particular finding does not
speak to whether strict non-compete enforcement is harmful to the nation as a whole.
24
V. Directions for Reform
Until recently, the lack of comprehensive data and analysis of non-competes made it difficult to
evaluate the institution from a public policy perspective. However, recent research has
underlined some important stylized facts that help to inform ideal policy and distinguish between
various possible explanations for non-competes. First, non-competes are common in the labor
market across educational, occupational, and income groups. Many workers who do not report
possessing trade secrets are nonetheless covered by non-competes.
41
Second, workers are often
poorly informed about the existence and details of their non-competes, as well the relevant legal
implications. Some employers appear to be exploiting this lack of understanding in ways that
harm workers without producing corresponding benefits to society. Finally, while non-compete
enforcement is associated with increased training for some workers, the details of this
enforcement are important: strong “consideration” requirements can support training and wage
growth while diminishing the likelihood that non-compete contracts result purely from
inadequate worker knowledge.
The following are general reform recommendations related to the enforcement and use of non-
compete contracts. They are not intended to be detailed or exhaustive. Nonetheless, these are
promising avenues for state and/or federal policymakers to explore.
Increase transparency in the offering of non-competes.
Policymakers should act to inject transparency into the world of non-competes. To the extent
that firms are simply misleading their prospective workers, non-competes are straightforwardly
negative for employees. It is important to be precise about the forms that worker confusion can
take. Some workers may simply not realize that they have signed a non-compete or fail to
understand its ramifications. This sort of confusion could be addressed by a requirement that
employers make the contracts, as well as their implications for future mobility, more salient for
workers at the outset of an employment relationship. Relatedly, some workers who are aware of
their non-compete contract may nonetheless be confused about its legal enforceability.
41
It is worth noting, however, that this is based on worker self-reports; employers may disagree.
25
Encourage employers to use enforceable non-compete contracts.
Many firms write non-compete contracts that contain unenforceable, overbroad provisions.
Given the well-documented worker confusion about these contracts and the very low cost of
writing an unenforceable contract, employers can exert a chilling effect on worker behavior even
when their contracts are unenforceable. Conversely, states should explicitly specify the
constraints on enforceability of non-compete contracts, where possible.
Require that firms provide “consideration” to workers bound by non-compete contracts in
exchange for both signing and abiding by non-competes.
Some firms already provide severance payments to workers with non-competes.
42
For instance,
a worker who quits may receive 50 percent of her previous salary in exchange for abiding by the
terms of the non-compete. This limits the harm to workers while ensuring that firms retain the
ability to protect their interests with non-competes. Importantly, by requiring that firms incur a
cost when requesting a non-compete, this policy preserves the most socially valuable non-
compete agreements and discourages the least valuable, for which firms would not be willing to
pay.
Conclusion
Non-competes are a central labor market institution, with nearly one fifth of all American
workers currently bound by such a contract. Surprisingly, non-competes are widely distributed
across education, occupation, and income groups. Understanding the consequences of this
institution for workers and the broader economy is therefore of great importance, especially in
light of its central role in determining workers’ prospects for wage growth and job mobility.
42
See http://www.sec.gov/Archives/edgar/data/320187/000119312510161874/dex1023.htm.
26
Though non-compete contracts can have important social benefits, principally related to the
protection of trade secrets, a growing body of evidence suggests that they are frequently used in
ways that are inimical to the interests of workers and the broader economy. Enhancing the
transparency of non-competes, better aligning them with legitimate social purposes like
protection of trade secrets, and instituting minimal worker protections can all help to ensure that
non-compete contracts contribute to economic growth without unduly burdening workers.
Ryan Nunn in the Office of Economic Policy was the principal drafter of this report. Inquiries
should be directed to the Office of Economic Policy at (202) 622-2200.
27
Appendix A
Modern interpretations of non-compete agreements are often said to have their origin in
15
th
and 16
th
century English common law and are best understood in the context of that period’s
economic structure. The guild economy largely comprised three types of workers: the
apprentice, the journeyman, and the master craftsman. Custom required apprentices to train
under master craftsmen for an extended period until graduating to the status of journeyman.
Once a journeyman, the individual was free to work wherever he wished while he sought
entrance into the inner circle of master craftsmen. Non-compete agreements likely originated in
this context as journeymen replaced retiring master craftsmen by purchasing their businesses.
43
However, available case law suggests English courts tended to disfavor restraints on trade –
especially restraints initiated by an employer.
The most cited example from this period comes from The Dyer’s Case of 1414.
44
This
case is perhaps the first known example of a contractual restraint of trade. A London practitioner
prohibited his apprentice from pursuing his trade in the same city for six months following his
apprenticeship. The court ruled against the covenant.
45
According to some commentators, the
result produced two fundamental pillars of employment law.
46
The first was a policy in favor of
retaining skilled labor in the public domain. The second pillar promoted the right of all
individuals to seek a livelihood. These principles guided legal precedent for the next century.
Over time, some master craftsmen began to take on more apprentices than customary so
as to employ a larger staff at low cost.
47
The consequence of this strategy was an influx of
journeymen looking for ways to unseat master craftsmen. Some craftsmen addressed the
increased levels of competition by requiring apprentices and journeymen to sign non-compete
agreements.
48
The English Parliament brought attention to some of these practices in 1536 by
authoring the Act for Avoiding of Extracting Taken upon Apprentices.
49
The law attempted to
43
Harlan M. Blake, Employee Agreements Not to Compete, 73 Harvard Law Review 638 (1960).
44
The Dyer’s Case, Y.B. Mich. 2 Hen. 5, fol. 5, pl. 26 (1414).
45
Ibid.
46
Dan Messeloff, Giving the Green Light to Silicon Alley Employees: No-Compete Agreements between Internet
Companies and Employees under New York Law, Fordham Intellectual Property, Media and Entertainment Law
Journal, (vol. 11, issue 3, 2001), at 710-711. Much of this appendix benefits from this article.
47
Blake, supra note 39, at 633.
48
Ibid.
49
Bland, Brown & Tawney, English Economic History – Select Documents, (1919), at 284-286.
28
restrain some of the practices of guild masters – including non-compete contracts. In 1563, the
Statute of Artificers restricted the privileges of workers while also shifting power from guild
masters to the evolving English state.
50
The law established national constraints on maximum
wages and the length of apprenticeships.
51
By the beginning of the 17
th
century, courts continued to disfavor employment restraints,
whether in the form of time or place. An excerpt from Colgate v. Bacheler (1602) notes, “For as
well as [employers] may restrain [employees] for one time, or one place, [they] may restrain
[them] for longer times, and more places, which is against the benefit of the Common-wealth….
For he ought not be abridged of his Trade, and Living.”
52
Others worried that non-compete
covenants forced young men into “idleness”.
53
However, as a new economic system emerged,
English courts began to rethink their position on non-compete covenants.
Mitchel v. Reynolds (1711) marked a distinct shift away from the practice of completely
banning non-competes.
54
Reynolds, a baker, agreed to rent his bakery for five years. In return,
Mitchel pledged Reynolds a bond worth 50 pounds on the condition that Reynolds would not
resume his trade within St. Andrew Holborn Parish for 5 years. The latter failed to keep the
agreement and Mitchel sued. Chief Justice Parker ruled in favor of the agreement.
55
He
reasoned that while general restraints on trade were unlawful, as they benefited neither party,
some partial restraints were reasonable.
56
Effectively, the ruling permitted individuals to enter
agreements even if they restricted one’s ability to work in a particular location or for a certain
period, as long as both parties and the affected communities benefited from the arrangement.
However, employers were required to demonstrate the economic necessity of any such
agreement.
50
Donald Woodward, The Background to the Statute of Artificers: The Genesis of Labour Policy, 1558-63, The
Economic History Review (vol. 33, no.1) 1980, at 32-44.
51
Ibid.
52
Cro. Eliz. 872, 78 English Report 1097, (Queen’s Bench 1602).
53
Case of Tailors of Ipswich, 77 English Report 1218, 1219 (King’s Bench 1614).
54
Mitchel v. Reynolds, 24 English Report 347 (Queen’s Bench 1711).
55
Dan Messeloff, Giving the Green Light to Silicon Alley Employees: No-Compete Agreements between Internet
Companies and Employees under New York Law, Fordham Intellectual Property, Media and Entertainment Law
Journal, (vol. 11, issue 3, 2001), at 710-711.
56
“General” restraints were defined as those with unlimited scope in either time or space, while “partial” restrains
were those limited in both dimensions.
29
The economic significance of non-competes evolved as new technology accompanied the
Industrial Revolution.
57
Once limited to local markets, companies began expanding into national
and international markets, exposing themselves to new rivals.
58
Moreover, corporations were
increasingly concerned with worker mobility. Leaving one’s town no longer carried the same
economic and physical risks. Homer v. Ashford (1825) describes the logic applied by English
courts on matters of non-compete covenants:
A merchant or manufacture would soon find a rival in every one of his
servants if he could not prevent them from using to his prejudice the
knowledge they acquired in his employ. Engagements of this sort between
masters and servants are not injurious restraints of trade, but securities
necessary for those who engage in it. The effect of such contracts is to
encourage rather than cramp the employment of capital in trade and the
promotion of industry.
59
Some took the argument of the court to suggest that non-compete clauses were
permissible in most circumstances. Six years later, the court clarified that while employers
should have access to protection, Mitchel’s test-of-reason still applied. In Horner v. Graves
(1831), a dentist’s assistant contracted to not practice independently within 100 miles of the
original employer.
60
Soon after parting with his employer, the assistant broke the agreement,
prompting the dentist to sue. In response, the court sided with the defendant, explaining that a
reasonable restraint must also account for the interests of the public. From the public’s
perspective, the dentist had sought to withhold a valuable service within the 100 mile radius of
his practice in order to protect himself. The court determined that the burden placed on the
public was greater than the need to protect the interests of the previous employer and that the
requirement was unreasonably broad.
61
The intermittent reweighting of employer, worker, and public interests continued as the
19
th
century wore on. By 1841, although most English courts still rejected general restraints,
some began to enforce them as businesses globalized.
62
A trend toward pro-employer policy
57
See Messeloff, supra note 42, at 712-713.
58
Blake, supra note 39, at 638.
59
Homer v. Ashford, 3 Bing. 322, 327 (1825).
60
7 Bing. 735, 131 English Report 284 (C.P. 1831).
61
Ibid. at 743.
62
Blake, supra note 39, at 624.
30
continued in 1853 when the Queen’s Bench ruled that the burden of showing unreasonableness
rested on the employee rather than employer.
63
In 1875, the court ruled that while contracts must
remain reasonable, a central value of the liberal economic philosophy permitted men of sound
mind to enter arrangements as they saw fit.
64
Increasing emphasis on freedom of contract was
evident in Rousillon v. Rousillon (1880), where the court allowed covenantal protection to extend
beyond national borders. The court reasoned that if the contract was reasonable in scope at the
negotiation, changing economic circumstances should not bar enforcement.
65,66
As English courts were moving toward pro-employer policies, American courts started
developing their own body of common law. In 1851, Lawrence v. Kidder, a case before the New
York Supreme Court, established a precedent that the state’s priority was to deter
monopolies.
67,68
The court reasoned that as far as possible, the state must ensure that all citizens
be permitted to work.
69
As such, the court viewed agreements which barred individuals from
practicing their occupations based on state or territory boundaries as unlawful.
A Pennsylvania court made an important distinction in 1866 between the sale of
“handicraft” and the sale of “property”.
70
The Pennsylvania court deemed restrictions on
property much more reasonable than restrictions on the use of an employee’s skills. This
distinction laid the foundation for the landmark Supreme Court decision in Oregon Steam
Navigation Co. v. Winsor (1874).
71
The California Steam Navigation Company sold the Oregon
Steam Navigation Company a boat under the condition that they would not operate the vessel
within California for a period of ten years. The Oregon Steam Navigation Company
subsequently sold it to Winsor, who at the time of sale was engaged in the navigation of water in
Washington. The sale was subject to a condition (among others) that Winsor would not operate
the boat in California for a period of ten years. The court upheld the condition, noting that there
was no injury to the public.
72
63
Tallis v. Tallis, I El. & B. 391, 118 English Report 482 (Queen’s Bench 1853).
64
Printing & Numerical Registering Co. v. Sampson, L.R. 19 Eq. 462 (1875).
65
14 Ch. D. 351 (1880).
66
Blake, supra note 39, at 641.
67
10 Barb. 641 (N.Y. Supreme Court 1851)
68
Blake, supra note 39, at 644.
69
Ibid.
70
Keeler v. Taylor, 53 Pa. 467, 470 (1866).
71
Messeloff, supra note 42, at 720-721.
72
Ibid.
31
The New York Court of Appeals echoed the opinion of the Supreme Court in 1887 when
it ruled in favor of a non-compete clause which restricted selling matches in the states of Nevada
and Montana.
73
The court found that the condition was a “partial” restraint even though it
covered the entire state of New York, while noting that the distinction between “general” and
“partial” restraints, while still good law, was weakening.
74
Non-compete policies began diverging across states by the end of the 19
th
century.
Notably, the California legislature rendered non-competes generally unenforceable.
75
Outside of
legal opinions, the most influential American documents on contract law are the “Restatement of
Contracts” of 1932 and its revision in 1979.
76
Though non-binding, these writings, published by
the American Law Institute, codify case law. Both versions of the Restatement of Contracts state
that restraints are unlawful if they unjustly benefit employers and impose undue hardship on the
employee or public – reflecting the opinion in Horner v. Graves.
77
The second Restatement of
Contracts protects the employee further by increasing the standard by which an employer must
demonstrate legitimate need for non-compete protection.
78
73
Diamond Match v. Roeber 106 N.Y. 473 (1887).
74
Messeloff, supra note 42, at 722.
75
Messeloff, supra note 42, at 714.
76
Ibid. at 723-724.
77
Ibid.
78
Ibid.
32
Appendix B
The following figures show some of the state heterogeneity in non-compete enforcement as of
2015. Note, however, that they reflect one particular expert’s view of state law, and may elide
distinctions relevant to some specific cases.
79
79
Hawaii considers trade secrets to be a protectable interest, is undecided on the question of enforcement against
workers fired without cause, and regards continued employment as sufficient consideration. Alaska is identical,
with the exception that it is undecided as to whether continued employment constitutes sufficient consideration.
Not applicable
Not protectable
Protectable
Source: A State by State Survey of Employee Noncompetes, Beck Reed Riden
Trade Secrets as Legitimate Interests
Not applicable
Undecided
Not enforceable
Enforceable
Source: A State by State Survey of Employee Non-competes, Beck Reed Riden
Enforceable Against Workers Fired Without Cause
33
Not applicable
Undecided
Not sufficient consideration
Sufficient consideration
Source: A State by State Survey of Employee Noncompetes, Beck Reed Riden
Continued Employment as Sufficient Consideration
34
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