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Scientific Proof Competition Is Good for Business

Recent research shows that states that forbid noncompete agreements (or don't enforce them) are more innovative than those that allow them.
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Lack of competition is bad for business. It tends to squelch good ideas and favor very big, entrenched companies over smaller enterprises.

Perhaps no other state typifies that dichotomy as much as California, where employee noncompetition agreements, which prevent workers with trade knowledge from taking jobs with competitors, are completely unenforceable, and have been for over a century. And yet it's the most innovative and entrepreneurial state in the union.

Still, those essential principles have been under attack in the Golden State, as clearly evidenced last week when more details emerged from a class action lawsuit launched by Silicon Valley engineers against some of the biggest names in tech, including Apple, Google, Intel, and Adobe. The companies were accused of enforcing secret noncompetes with each other--preventing them from hiring each other's key engineers, to suppress wages and prevent bidding wars for talent. (The class action was settled for an undisclosed amount on Thursday.)

There's plenty of proof that anti-competitive behavior in the business world causes more damage than gain. And surreptitious noncompete agreements, such as those the tech giants had in place with their employees, can also take a toll on worker wellbeing and productivity, as employees may miss out on educational opportunities and new experiences. They also inhibit employee mobility--which, research shows, can reduce innovation, since people are less able to pursue ideas and take risks. 

"All advantages come from states the don't enforce noncompetes," says Alan Hyde, a professor of law at Rutgers University, who has studied the phenomenon. Among those states are California, Colorado, and Oregon. Hyde is the author of Working in Silicon Valley: Economic and Legal Analysis of a High-Velocity Labor Market.

Generally speaking, noncompete agreements are legal contracts that prevent employees from starting a competing business or going to work for a competitor if the employee has confidential information or access to trade secrets from the prior company. Such agreements can last multiple years, during which time the employee can get rusty and lose the edge his knowledge previously gave him, experts say.

There's no federal law governing noncompete agreements. Instead, states have their own laws. Some, such as New Jersey, allow business owners to enforce noncompetes with employees. Although New Jersey is one of the wealthiest and most educated states in the U.S., it almost entirely lacks a startup culture as well as venture capital firms supporting startups, according to recent research by Hyde on competition in labor markets.

Similarly, in a landmark study from 2011, Matt Marx, a professor at MIT's Sloan Management School, studied what happened when Michigan repealed state laws in 1985 that forbade noncompete agreements. By examining patent data for the state, Marx found a nearly 10 percent drop in the mobility of the state's inventors, and a flatlining in the number of new patents after the new laws took effect.

Looking at patent data nationally, Marx identified a brain drain of inventors from states that enforce noncompetes to ones that don't.

A Workaround

Critics of these theories say investors won't invest in companies that don't have noncompete agreements in place, because that protects the investment. But Hyde counters that such agreements aren't legal in California, which has more venture-capital deals than any other state.

John Backus, managing partner of New Atlantic Ventures, says his firm rarely insists on noncompete agreements. New Atlantic is headquartered in Cambridge, Massachusetts. The state currently enforces noncompete agreements but has pending legislation to overturn those laws, moving it toward a California model.

Instead, Backus says his firm always insists on an intellectual property assignment agreement, which gives ownership of inventions to the company but doesn't hobble the mobility of the inventor.

"It means that if they work at the company, they agree to assign anything they invent at the company, on company time, to the company," Backus says. "It is just good housekeeping to do that."

Last updated: Apr 28, 2014

JEREMY QUITTNER | Staff Writer | Staff Writer, Inc. and Inc.com

Jeremy Quittner is a staff writer for Inc. magazine and Inc.com. He previously covered technology for American Banker and entrepreneurship for BusinessWeek.




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