New Research Examines Non-Compete Agreements and Their Effect on Entrepreneurship

New management research from the Martin J. Whitman School of Management at Syracuse University offers new insight into the practice of non-compete agreements common in many industries across the country.

Non-competes are often in place so companies can protect innovations/ideas and confidential information and, according to a White House report released in May, 2016, “can play an important role in protecting a business,” when used appropriately. However, in the article, “Screening spinouts? How noncompete enforceability affects the creation, growth and survival of new firms,” Natarajan Balasubramanian, associate professor of management at the Whitman School, and his co-authors, Evan Starr (University of Maryland) and Mariko Sakakibara (University of California, Los Angeles), find that there can be a significant effect on entrepreneurship relating to non-compete agreements, too.

“Non-competes are useful because they can motivate firms to invest in their employees without fear that the employee will take their newfound knowledge elsewhere,” said Dr. Balasubramanian. “But they can also make it harder for employees to leave their employers to form competing start-ups.”

Dr. Balasubramanian said there is an intense ongoing debate about whether non-compete agreements should be enforced or not by courts. Eight states in the last three years have sought to join California and North Dakota as the only states to ban these agreements. This study aims to provide the first direct empirical evidence on how the enforceability of non-compete agreements affects entrepreneurship.

“California’s non-enforcement of non-competes has been cited as one reason for the start-up culture of the Silicon Valley,” said Dr. Balasubramanian. “It’s common for employees to move from one firm to another, as well as to leave a firm to start their own business. New ideas are moving from place to place constantly, which some have suggested helps contribute to the vibrant economy in that area of the country.”

The research found that in states where there is strict enforcement of non-competes, there are fewer spinouts, or employees leaving their firms to start their own businesses, in the same industry as the firms the employees are departing. Rather, employees are more likely to migrate to a different industry to start their business.

“This finding is intuitive to some extent,” said Balasubramanian. “We would expect that in states where non-competes are strictly enforced, it would preclude employees from being able to leave and start a new business in direct competition with their former employers.”

But, what the researchers also found that while stricter enforcement reduces the entry of within-industry spinouts, those that are formed tend to be larger and better-performing, consistent with enforceability screening out poorer quality entrants from the market.

The study is forthcoming in Management Science.