When Noncompete Agreements Hurt Everyone

When employees sign noncompete agreements, they are bound from changing jobs within their industry or breaking out to start a company on their own. These agreements have been upheld in most states based on an employee’s freedom to enter into contracts. But what are the consequences for the labor market as a whole when these contracts are enforceable and used en masse? New research finds that the mass use of enforceable noncompetes is associated with negative consequences for the whole labor market, even for those who don’t have to sign them.

Evan Starr and Rajshree Agarwal, both management professors at the University of Maryland’s Robert H. Smith School of Business, worked with Justin Frake, a Smith PhD grad now at the University of Michigan. They found that in states and industries where noncompete agreements are commonplace and actively enforced, all workers – even those not bound by such agreements – get fewer job offers, endure lower wages, have less job mobility and experience lower levels of job satisfaction.

For one thing, say the researchers, noncompetes stifle entrepreneurship, by preventing workers from quitting and starting their own rival companies. As a result, there is reduced competition for all workers, even those who do not have noncompetes. In addition, the presence of enforceable noncompetes causes congestion in the hiring process, preventing or delaying firms from hiring workers who would actually join them.

“While most of the arguments related to the pros and cons of noncompetes have focused on those party to the contract, the key point of this study is that the mass use of enforceable noncompetes has negative implications for all workers, including those unbound by noncompetes,”  says Starr.

The researchers found that the tighter a state’s noncompete laws are enforced, the more all workers are hurt by them. They advocate loosening those laws.

In March 2019, Maryland and other states reached settlements with four national fast-food chains to end the practice of having low-wage workers sign agreements that prevented them from switching jobs to other chains. Starr says this good for workers. He and his co-authors call on policymakers to restrict noncompete agreements to minimize the negative market effects they are having.

Read more: Mobility Constraint Externalities is featured in Organization Science.