Non-competes Push Talent Away
California is among several states where non-compete agreements are essentially illegal. Is it a coincidence that so many inventors flock to Silicon Valley? New research by Lee Fleming, Matt Marx, and Jasjit Singh investigates whether there is a "brain drain" of talented engineers and scientists who leave states that allow non-competes and move to states that don't. Key concepts include:
- The research shows that inventors are leaving states that allow non-competes and moving to states that don't.
- The results are most pronounced among those inventors with the most patent citations—that is, those who are most productive, collaborative, and valuable to their firms.
- The researchers hope that their study will induce state legislators to consider regional rules regarding non-compete agreements.
Several years ago, on his first day of work at a Boston-based speech-recognition software company, Matt Marx's new employer surprised him with a non-compete agreement. The terms stated that if Marx left the company, he couldn't work anywhere else in the industry for two years. While he was disturbed that nobody had mentioned the non-compete before he accepted the job, Marx signed willingly, assuming such documents were commonplace.
"It's clear that that inventors are leaving states that enforce non-competes for states that don't."
Fast-forward a few years later. Marx was a manager at a start-up firm in Silicon Valley when one of his employees decided to quit and go work for a direct competitor down the street. "I told him, 'Hey, you can't do that. Didn't we make you sign a non-compete?' " Marx recalls. "He kind of laughed at me and said that non-competes weren't enforceable in California.
Sure enough, California is among several states where non-compete agreements are substantially restricted by law, along with Alaska, Connecticut, Minnesota, Montana, Nevada, North Dakota, Oklahoma, Washington, and West Virginia. So, even if someone signs a non-compete agreement in Massachusetts, for instance, a judge in California is not obligated to enforce the contract because it conflicts with California state law.
"There's a saying out in California: You never stop hiring someone," says Marx (MBA '05, DBA '09), now an entrepreneurship professor at MIT Sloan who wrote his dissertation on non-competes while in the doctoral program at Harvard Business School. "There's an open labor market," he continues. "People can leave when they want. They're not trapped at companies the way they are in Massachusetts. And that's what changed the way I worked as a manager. I realized that I couldn't treat employees like resources. I had to work to keep them excited to stay around."
Marx is the coauthor of a yet-to-be-published paper that investigates whether states that allow non-compete agreements are driving high-tech talent away—creating a so-called brain drain of smart inventors. In "Regional Disadvantage? Non-Compete Agreements and Brain Drain," the researchers show that non-competes indeed factor into an inventor's decision to emigrate, within the United States, to states that disallow non-competes.
"It's clear that inventors are leaving states that enforce non-competes for states that don't," says Lee Fleming, a professor at Harvard Business School who coauthored the paper with Marx, along with INSEAD professor Jasjit Singh (PhDBE '04).
To test their brain drain theory, the researchers analyzed the US patent record from 1975 to 2005, in order to track the emigration patterns of hundreds of thousands of inventors over two decades. (They considered only inventors who held multiple patents.)
"Patenting inventors represent an important category of skilled workers involving the sorts of trade secrets firms seek to protect using non-competes," their paper explains. "Each patent typically contains each inventor's hometown and employer, making it possible to reconstruct work histories and co-authorship networks for numerous individuals."
Initially, the researchers looked for emigration patterns in the United States. In attempting to define the non-compete status in Michigan, they discovered a natural test bed, thanks to an inadvertent policy change. In 1905, during the initial automotive industry boom, Michigan passed Public Act No. 329, which prohibited "all agreements and contracts by which any person…agrees not to engage in any avocation or employment"—including non-compete agreements. But in 1985, the state passed the Michigan Antitrust Reform Act (MARA), which sweepingly repealed dozens of laws and acts, including the inadvertent repeal of Public Act No. 329. Suddenly, non-compete agreements were legal in Michigan.
"This is an ideal natural experiment where you take a population of people—namely, the inventors in Michigan before the law changed—and then you subject them to this shift in enforcement," Fleming explains.
"Policy makers in these states are really shooting themselves in the foot."
The results showed that the legalization of non-competes had a definite brain drain effect. Indeed, after the passage of MARA, more inventors left Michigan for states that did not enforce non-competes than for states that did.
The paper explains that from 1975 to 1996—the period surrounding the 1985 policy reversal—the rate of emigration grew in Michigan (0.24% to 1.18%) while dropping in states that did not enforce non-competes (0.20% to 0.13%). The relative risk of post-MARA emigration was 1.353 in Michigan, 99.9% higher than in states that continued not to enforce non-competes (where the relative risk of post-MARA emigration was 0.677). Furthermore, the Michigan emigrants primarily were moving to states that did not enforce non-competes.
While the results supported the brain drain hypothesis, the researchers worried that they might be skewed by patent holders who had moved to California, a state that might be especially attractive to inventors irrespective of its non-compete policies, which have been in effect since 1872. In both landmass and population, California is disproportionately large compared with most other states, which could account for more job opportunities. Silicon Valley, especially, is known as an inventor's mecca. And let's not forget the incessant sunshine.
"The problem was causality," Fleming says. "Are people going to California because they're trying to get out of the non-compete in their original state, or are they going to California for the weather or whatever else?"
That in mind, the research team investigated whether the results would change if they excluded all the data related to inventors who moved to California. Indeed, even without the pull of Silicon Valley, the brain drain theory still held true: Michigan inventors also tended to emigrate to other states that disallowed non-competes.
The best and brightest
The researchers found that the brain drain was especially pronounced among inventors who held multiple and high-impact patents, and among inventors who also collaborated widely—in other words, those who were considered most valuable to innovation in their firms
The relative risk of post-MARA emigration by more productive inventors, holding more than the median number of overall patent citations, was 187 percent higher in Michigan than in states that continued not to honor non-competes. But the relative risk of post-MARA emigration by Michigan inventors at or below the median number of patents was only 46 percent higher.
"I think the real punch line here is that it appears that it's the better inventors who are more likely to respond to these laws," Fleming says. "It's the people who have lots of patents, it's the people who have high-impact patents, it's the ones with many coauthors. Prior research has shown that the best engineer is worth much more than the average engineer. And if those are the people whom the states are losing, it's a big hit. Policy makers in these states are really shooting themselves in the foot. Some have argued that firms will not invest in R&D unless they can keep their people, but other research by Mark Garmaise at UCLA has shown just the opposite."
To that end, Marx and Fleming have shared their findings with government officials in their home state of Massachusetts, where legislators are considering a bill that would restrict the terms of non-compete agreements in the state. A hearing is set for September 15. Brain drain is arguably an issue in Massachusetts, which reportedly retains only about 60 percent of its college graduates.
Meanwhile, they hope hiring managers will take the issue to heart.
"If you're starting a company, you might want to think about non-competes when you talk about where to locate your business," Marx says. "And if you're considering non-competes, think about whether you want to develop a reputation as a company that tries to put a hammerlock on your employees."