Non‐competes, business dynamism, and concentration: Evidence from a Florida case study

• DOI: http://doi.org/10.1111/jems.12349
• Author: Hyo Kang,Lee Fleming
• Published date: 01 July 2020
• Date: 01 July 2020

J Econ Manage Strat. 2020;29:663–685. wileyonlinelibrary.com/journal/jems © 2020 Wiley Periodicals, Inc.

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663

Received: 6 November 2017

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Revised: 11 February 2020

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Accepted: 1 April 2020

DOI: 10.1111/jems.12349

ORIGINAL ARTICLE

Non‐competes, business dynamism, and concentration:

Evidence from a Florida case study

Hyo Kang

1

|Lee Fleming

2

1

Department of Management and

Organization, Marshall School of Business,

University of Southern California, Los

Angeles, California

2

Fung Institute for Engineering

Leadership and Haas School of Business,

University of California, Berkeley,

Berkeley, California

Correspondence

Lee Fleming, Fung Institute for

Engineering Leadership and Haas School

of Business, University of California, 2451

Ridge Rd, Berkeley 94709, CA.

Email: lfleming@berkeley.edu

Funding information

Division of Social and Economic Sciences,

Grant/Award Number: 1661311; Ewing

Marion Kauffman Foundation,

Grant/Award Number: CrowdFunding

Research

Abstract

Most research on non‐competes has focused on employees; here we study how

non‐competes affect firm location choice, growth, and consequent regional

concentration, using Florida's 1996 legislative change that eased restrictions on

their enforcement. Difference‐in‐differences models show that following the

change, establishments of large firms were more likely to enter Florida; they

also created a greater proportion of jobs and increased their share of em-

ployment in the state. Entrepreneurs or establishments of small firms, in

contrast, were less likely to enter Florida following the law change; they also

created a smaller proportion of new jobs and decreased their share of em-

ployment. Consistent with these location and job creation dynamics, regional

business concentration increased following the law change in Florida.

Nationwide cross‐sections demonstrate consistent correlations between

state‐level non‐compete enforcement and the location, employment, and

concentration dynamics illustrated in Florida.

KEYWORDS

business concentration, business dynamism, employee mobility, entrepreneurship, firm sorting,

non‐compete agreement

JEL CLASSIFICATION

J61; L22; L26; M13; M51

1|INTRODUCTION

Most research on non‐competes to date has focused on how such laws impact employees (Garmaise, 2009; Marx,

Strumsky, & Fleming, 2009, Starr, 2019), patenting (Conti, 2014), and entrepreneurship (Samila & Sorenson, 2011;

Starr, Balasubramanian, & Sakakibara, 2017). Less research has considered how non‐competes impact firms’decisions,

how those decisions might vary by the type of firm, and the ultimate impact of those decisions on industries and

regions. Here we document how one state's change in non‐compete laws influenced firms’strategic choices and

preceded change in the competitive dynamics and industry concentration in that state.

Recent work has documented trends of increasing industry concentration, possibly due to scale and network effects

(Shambaugh, Nunn, Breitwieser, & Liu, 2018), deregulation (De Loecker, Eeckhout, & Unger, 2018), or efficiencies of

scale, mergers and acquisitions, innovation, or regulatory barriers (Council of Economic Advisors, 2016). Other work

has documented a broad decline in business dynamism across many sectors in the United States, including a flat trend

in firm exit and declining trends in firm entry and job reallocation (Hathaway & Litan, 2014) and a decrease in

entrepreneurship (Haltiwanger, Jarmin, & Miranda, 2013). Hathaway and Litan (2014) comment that, “Whatever the

reason, older and larger businesses are doing relatively better to younger and smaller ones.”A White House (2016)

policy brief documents a decline in competition, new firm formation, and business dynamism—and associates these

trends with state level non‐compete laws that typically decrease workers’mobility. Scatter plots at the state level,

illustrated in Figure 1, also reveal positive relationships between enforcement of non‐competes and the share of large

firms, job creation by large firms, and regional business concentration. Such plots, however, are static and bivariate,

surely mask omitted variable bias, and like other work that has only documented the trends, “…remain[ed] silent on the

causes.”(De Loecker et al., 2018, p. 32)

To investigate one dynamic that could give rise to increased business concentration, we identify a clear change in

one state's non‐compete laws, a subsequent change in establishment entry and employment by firm size, and a

consistent effect on business concentration. We begin by documenting recent changes in non‐compete laws across all

U.S. states and establish that Florida's 1996 non‐compete law provides an unambiguous step change that strengthened

enforcement. Other states have also changed their non‐compete laws, though not as cleanly for the purposes of isolating

the impact of non‐competes on business concentration. For example, Michigan's 1985 change—the Michigan Anti‐trust

Reform Act—was explicitly intended to increase competitiveness; the legislators and analysts had no intent to change

non‐compete law (Marx et al., 2009). Florida's experience appears internally consistent and provides an example of a

plausible pathway from non‐compete enforcement to business concentration. We discuss and illustrate possible me-

chanisms, but hesitate to claim wide applicability and external validity, due to the difficulty of generalizing across the

many idiosyncrasies that accompany each state's change in non‐compete laws, and the many potential influences on

business concentration.

Florida's sharp legislative change in non‐compete enforcement illustrates how non‐compete laws can alter business

dynamism and the regional size distribution of firms. The law change appears to have favored establishments of larger

firms, and such firms created more new jobs. Stronger enforcement did not increase the establishment of start‐ups, the

arrival of small firms to the state, and job creation by such firms. Consistent with these trends, we find a significant

increase in business concentration measures following Florida's strengthening of non‐competes. These results are

robust to analyzing adjacent counties on Florida's borders, synthetic matching, industry matching, and placebo tests,

and are consistent with a nationwide cross section of states’non‐compete enforcement and shares of establishment

entry, employment growth, and business concentration.

2|EMPLOYEE NON‐COMPETES

If you are a chief executive of a large company, you very likely have a non‐compete clause in your contract,

preventing you from jumping ship to a competitor until some period has elapsed. Likewise if you are a top

engineer or product designer, holding your company's most valuable intellectual property between your ears.

And you also probably have a non‐compete agreement if you assemble sandwiches at Jimmy John's sub

sandwich chain for a living (Irwin 2014).

Covenants not to compete (“non‐competes”) are agreements in which an employee agrees not to work for the

current employer's direct competitors in a specified area for a certain amount of time. They are becoming increasingly

prevalent in many industries besides high technology (Starr, 2019); 351 of 500 U.S. firms (70.2%) reported non‐compete

agreements for their top executives (Garmaise, 2009).

1

Amazon requires their employees, including part‐time laborers,

to sign non‐competes, under which they will not work at “any company where they directly or indirectly support any

good or service that competes with those they helped support at Amazon (Woodman, 2015).”

2

Physicians, dentists,

accountants, and even lawyers can be subject to non‐competes (Tanick & Trobaugh, 2012).

Non‐competes have developed in part because employers typically prefer labor contracts that aid in the retention of

desirable employees. Such contracts intend to mitigate the market failure of under‐investment in employee training and

research activities (Samila & Sorenson, 2011). With non‐competes in place, employers can invest in their employees and

provide confidential yet necessary information with less fear of information leakage or potential competition. Employees,

likewise, can credibly commit that they will not use the training and information for the benefit of a competitors.

Empirical work has established a variety of relationships with non‐compete enforcement, though little has focused

on how non‐competes affect existing firms. Stuart and Sorenson (2003) established that greater entrepreneurship

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KANG AND FLEMING