State enforceability of noncompete agreements: Regulations that stifle productivity!

• DOI: http://doi.org/10.1002/hrm.21840
• Author: Smriti Anand,Iftekhar Hasan,Priyanka Sharma,Haizhi Wang
• Published date: 01 January 2018
• Date: 01 January 2018

HR SCIENCE FORUM

State enforceability of noncompete agreements: Regulations

that stifle productivity!

Smriti Anand

1†

| Iftekhar Hasan

2†

| Priyanka Sharma

1†

| Haizhi Wang

1†

1

Stuart School of Business, Illinois Institute of

Technology, Chicago, Illinois

2

Fordham University, Bank of Finland, and

University of Sydney. 45 Columbus Avenue,

New York, NY 10023

Correspondence

Smriti Anand, Stuart School of Business,

Illinois Institute of Technology, 565 W. Adams

Street, Chicago, IL 60661.

Email: smriti.anand@stuart.iit.edu

Noncompete agreements (also known as covenants not to compete [CNCs]) are frequently

used by many businesses in an attempt to maintain their competitive advantage by safeguard-

ing their human capital and the associated business secrets. Although the choice of whether to

include CNCs in employment contracts is made by firms, the real extent of their restrictiveness

is determined by the state laws. In this article, we explore the effect of state-level CNC

enforceability on firm productivity. We assert that an increase in state level CNC enforceability

is detrimental to firm productivity, and this relationship becomes stronger as comparable job

opportunities become more concentrated in a firm’s home state. On the other hand, this nega-

tive relationship is weakened as employee compensation tends to become more long-term

oriented. Results based on hierarchical linear modeling analysis of 21,134 firm-year observa-

tions for 3,027 unique firms supported all three hypotheses.

KEYWORDS

CNC, employment contracts, firm productivity, noncompete agreements

1|INTRODUCTION

All organizations operate within the realm of their external environ-

ment from which they draw their inputs and into which they release

their outputs (Miles, Snow, & Pfeffer, 1974; Scott, 1981; Starbuck,

1976). The external environment of an organization consists of a

wide range of exogenous factors such as government laws and regu-

lations, societal culture, and general economic conditions (Duncan,

1972) that shape organizational effectiveness through their influence

on the organization’s ability to acquire, use, and retain resources

needed for value creation (Aldrich, 1979; Pfeffer & Salancik, 2003).

One of the most important resources needed for value creation in

contemporary businesses is human capital—a unique form of capital

arising from the skills and attributes embodied in the workforce

(Becker, 1964). As the U.S. economy has gradually evolved from a

labor-based economy to primarily a knowledge-based economy, firms

have become increasingly reliant on human capital to develop and

sustain their competitive advantages (Barney, 1991; Bishara, 2006).

However, despite its huge reliance on human capital a firm cannot

fully control this resource as it is completely contained within the

workforce. Firms often try to shield themselves from losing human

capital by incorporating a noncompete agreement or covenant not to

compete (CNC) into employment contracts. CNC refers to a restric-

tive clause in the employment contract, which forbids an employee

from competing with the former employer either by taking up

employment with a competing firm or by setting up a new start-up

within a certain geographic area within a certain length of time

(Bishara, Martin, & Thomas, 2015; Estlund, 2006; Malsberger, 2004;

Whitmore, 1989). Though inclusion of CNCs in employment con-

tracts is the purview of a firm, their enforceability is determined by

state labor laws that are a part of the firm’s external legal environ-

ment. State labor laws thus influence one of the most important

inputs needed by firms—human capital—and wield significant impact

on an organization’s productivity and competitiveness. Because firms

have virtually no control over these laws (Duncan, 1972), it is critical

for their managers to understand the relationship between the legal

environment and firm performance so they can devise strategies to

enhance firm effectiveness while abiding by the laws.

CNCs have become common in industries as diverse as biotech

and pharmaceuticals, high technology, book publishing, and education

(Garmaise, 2011; Gilson, 1999; Kaplan & Strömberg, 2003; Leonard,

†

All authors have equally contributed to the study; the names are ordered

alphabetically.

DOI: 10.1002/hrm.21840

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