Non-Compete Agreements
Author: Greyson Web
Publication Date: May, 2024.
In April, the Federal Trade Commission (FTC) issued a final rule banning enforcement of non-compete agreements. Non-compete agreements are legal contracts between an employee and their employer wherein the employee agrees not to work for a competing employer. The FTC contends that the nationwide ban on non-competes will foster competition in the labor market, foster innovation, and increase the formation of new businesses.
The original intent of these agreements was to protect employers from harm caused by former employees stealing trade secrets or client lists. However, a scandal over sandwich maker Jimmy John’s use of non-compete agreements for its minimum-wage workers made it clear that employers were using them to reduce turnover, prevent job competition, and gain leverage over employee raises.i Since then, new data documenting the widespread use of these agreements and research illustrating their anti-competitive effects have caused researchers to develop a much more pessimistic view on their effects. Today, there are alternative legal and contractual tools to address business owners’ legitimate concerns to non-compete agreements. In many states—red and blue alike—legislators have limited when and how non-compete agreements can be used and enforced.ii The new ban on non-competes is scheduled to take effect 120 days after the rule has been entered in the Federal Register, but is expected to be delayed pending court challenges.
Which workers are covered by non-compete agreements?
While non-compete agreements are an arcane area of employment law, the reality is that large numbers of workers are subject to them. Nationally, 11 percent of workers are covered by non-compete agreements. But what do we know about the workers bound by non-compete agreements? Are they knowledge workers that could disclose proprietary information? Or, are they workers unlikely to possess knowledge of trade secrets, such as Jimmy John’s Sandwich Artists, who are subject to the adverse effects of non-competes in their employment?
Using 2022 data from the Survey of Household Economics and Decision Making (SHED), we can gain insights into this question by examining the characteristics of workers covered by non-compete agreements. Figures 1 and 2 examine the income and educational attainment distribution of workers covered by non-compete agreements. These data show that, as expected, a large share of workers are higher-income and highly educated. For example, over half of workers covered by a non-compete earn more than $100,000 and over 60 percent have a college degree.
Figure 1 – Distribution of Earnings of Workers Covered by a Non-Compete Agreement
Note: Dollar amounts in thousands. Income ranges are defined to represent deciles of the distribution of earnings (i.e. 10% of all workers earn less than $13,000.) Source: Survey of Household Economics and Decision Making, 2022.
However, a non-trivial number of workers in lower-wage jobs, with lower levels of education, and in fields in which proprietary information is less likely to exist are subject to non-competes. About 40 percent of those covered by non-competes earn less than $100,000 per year, including about 25 percent who earn less than $60,000 per year, and about 12 percent below $29,000 per year. Nearly 40 percent of workers bound by non-compete agreements don’t have a college degree.
Figure 2 – Educational Attainment of Workers Covered by a Non-Compete Agreement Note: Source: Survey of Household Economics and Decision Making, 2022.
Figures 3 and 4 examine the prevalence of non-compete agreements by occupation and industry of all workers. For example, Figure 3 shows that about 27 percent of all workers whose occupations fall under the “Business Operations” category are covered by a non-compete agreement. Figure 4 shows that about 23 percent of workers in the Media/Information industry are similarly covered. Strikingly, these data also show that non-compete agreements are also prevalent for workers where there is likely to be little intellectual property, specialized trade secrets, or proprietary customer lists: in occupations like food service and delivery jobs, construction, health professions, or office administrators and assistants, or industries like healthcare, hospitality, retail, or education.
Figure 3 – Fraction of Workers Covered by Non-Compete Agreements by Occupation
Source: Survey of Household Economics and Decision Making, 2022.
Figure 4 – Fraction of Workers Covered by a Non-Compete Agreement by Industry
Source: Survey of Household Economics and Decision Making, 2022.
How do states regulate non-competes?
The enforceability of non-compete agreements varies widely across states – although they will soon be non-enforceable nationwide if and when the federal rule is effective. In Utah, non-competes are widespread because agreements are enforceable in a broad set of circumstances. Non-compete agreements in Utah can be applied to practically any worker, including low-wage or unskilled workers, workers without access to intellectual property, and in circumstances in which the employee receives little consideration for entering the agreement. In Utah, broadcasters are the only category of worker exempt from non-competes, representing an arbitrary carve-out for a preferred group. In 2016, legislation reduced the term of non-compete agreements to 12 months in the state.
Some states limit the enforceability of non-compete agreements. Non-compete agreements are entirely non-enforceable in four states — California, Minnesota (for agreements signed after July 1, 2023), North Dakota, and Oklahoma. In 38 states, including the four previously mentioned, non-compete agreements are non-enforceable for specific professions or categories of workers. In 22 states ranging from Alabama to Arkansas, Illinois to Indiana, and Tennessee to Texas, non-compete agreements cannot be enforced against physicians, and often, other healthcare workers, such as nurses, are exempt. In 11 states, enforcing non-competes on lower-income workers is illegal. In some of these states, this exemption extends to all hourly workers. In other states, the exemption is determined by a specified threshold on earnings, hourly wages, or the poverty line. For example, in Oregon, non-compete agreements may only apply to workers earning more than approximately $108,500. In Colorado, the threshold is about $112,000. Except for the protected category of broadcast workers, Utah has none of these income or industry-based exemptions.
Other legislation has attempted to increase transparency for workers or limit the application of non-compete agreements to longer-term employees. In about half of cases, the employee is not informed about the agreement or asked to sign until after they have taken the job, at which point, they may have little choice or negotiating power. Many states now require that workers be provided with the agreement prospectively before they accept the job. Some states limit enforcement based on the duration of employment, requiring an employee to be employed for a certain period of time (e.g., two years) before the agreement is enforceable.
What does the evidence suggest about the economic effects of non-compete agreements?
A sizable body of evidence suggests that non-compete agreements reduce wages, impair businesses from hiring, and reduce growth and innovation.
Empirical evidence suggests that non-compete agreements reduce wages and workers’ job mobility.ii, iii Non-competes suppress labor market competition for workers’ services because workers covered by a non-compete agreement may be unable to take higher-paid positions offered by other businesses with job vacancies.
Second, research shows that non-compete agreements reduce entrepreneurship and business growth. The mechanism is that non-compete agreements make filling vacancies harder for growing businesses, particularly in high-skill, specialized fields where non-competes are common.iv Non-competes may also prevent workers from starting new businesses, and limit the ability of new businesses to hire talented managers and experienced workers.
Third, non-compete agreements reduce innovation and productivity because they reduce the movement of workers across firms, which is an essential way that business best practices, managerial skills, and expertise travel throughout an industry.
Non-competes are often viewed as “good for business”, but often in a very narrow sense of that business’s relationship with a specific covered worker who faces the additional barrier to leaving the firm. But every worker who leaves one job for another is filling a vacancy and helping another business succeed. More often than not, the business hiring that worker expects to get more value from the relationship, resulting in heightened pay for the talented, experienced, or hard-to-find workers described above.
In short, the evidence suggests that a primary effect of non-compete agreements is to stifle competition in the pool of workers that exist between firms, which raises the question of why these agreements are legal. It is illegal for two competitive firms to agree not to hire the other firm’s workers. Indeed, Apple, Google, and other Silicon Valley firms recently paid $324 million in fines to workers harmed by “no-poaching” agreements. Non-compete agreements result in an identical outcome. Employers are barred from colluding with other firms to prevent them from hiring workers, but they are allowed to require employees to agree not to work at the competing firm. In this legal context, the primary purpose of a non-compete agreement is in its name—to avoid competition, reduce job mobility and turnover, and gain leverage over wages.
This doesn’t mean that the needs of businesses to prevent expropriation of intellectual property, trade secrets, proprietary client lists, or information should be ignored, however. Instead, there are better, more targeted legal tools and employment practices that businesses can utilize to achieve their legitimate business objectives.
In Utah, for example, robust laws independently protect and enforce intellectual property and trade secrets through non-disclosure agreements. Likewise, non-solicitation agreements can prevent employees or partners from poaching client lists. To the extent that employers invest time and money into training workers, they can hire workers with deferred compensation agreements, such as end-of-period bonuses or multi-year vesting periods for equity, which allow employers to recover long-term investments in training and skills or effectively recoup those costs if employees depart before the vesting period. Using these tools, Utah businesses can achieve their legitimate needs and protect their intellectual property and the without suppressing labor market competition. In this legal context, non-compete agreements can be viewed an excessive and unnecessary restraint on free markets and competition.
Prior to the FTC’s proposed rule, other states had changed their legal framework to prohibit or limit enforcement of non-competes in many circumstances or to require procedural rules that make their effects more apparent to workers before hiring. The FTC rule is expected to be challenged in court before it goes into effect, and whether it becomes law will depend on the outcome of that legal process. If it is struck down, Utah could consider exempting additional categories of workers in certain professions or lower-income workers. Other regulatory options include only allowing enforcement of non-competes after a specific duration of employment or requiring non-competes be presented at the time of initial job offer.