Enforcement of Non-Compete Agreements Impedes Entrepreneurship and Employment Growth

New Haven, Conn., December 15, 2009 — The enforcement of non-compete agreements, the clauses in employment contracts that prohibit individuals from competing with their former employers, significantly impedes entrepreneurship and employment growth, finds a new study by Professors Olav Sorenson of the Yale School of Management and Sampsa Samila of Brock University.

Enforcement of non-compete agreements creates a less entrepreneurial environment that makes it more difficult for employees to move from their existing employers to start-ups, or to start their own ventures. Sorenson and Samila find that this affects venture capital, an important factor that stimulates entrepreneurship, employment, and income growth. “If the employees that venture capital firms would like to fund in order to produce new, high potential businesses are locked up in existing companies by non-compete agreements, then it’s much harder for VCs to find good ventures,” said Sorenson.

While non-compete agreements have become common, their enforcement varies with labor laws from state to state. To understand how these differences in enforcement affect innovation and economic growth, Sorenson and Samila examined 328 metropolitan areas in the United States from 1993 to 2002. They assessed the state’s legal stance on enforcement, and estimated how effective the local supply of venture capital is in stimulating patenting, entrepreneurship, employment, and income growth.

Sorenson and Samila find that enforcement of non-compete agreements moderates the effects that venture capital has on entrepreneurship and the regional economy. According to the results, states that do not enforce non-compete agreements experience twice the increase in patents, twice the increase in new firms established, roughly three times the employment growth, and greater income growth in response to venture capital, relative to states that do enforce. Moreover, the large employment growth results suggest that a substantial portion of new jobs come not from new ventures created, but from spillovers in the region to established firms.
 
“States that have broader enforcement of non-compete agreements see weaker benefits to venture capital. For the same number of venture capital dollars, you see fewer new ventures created, fewer new jobs created, and less income growth in states that enforce non-compete agreements more strongly,” said Sorenson.

The study helps to explain why some regions benefit from venture capital more than others, for example, why Silicon Valley has been more successful in fostering a high tech cluster than Boston. California generally does not enforce non-compete agreements, while Massachusetts does.

“We’ve seen attempts around the world to develop venture capital communities, with varying degrees of success. Our research suggests that communities or states that implement programs to promote venture capital without adopting supportive labor laws may have little hope of seeing benefits from these programs,” said Sorenson.