When Do CEOs Have Covenants Not to Compete in Their Employment Contracts?

Abstract

When do American CEOs have covenants not to compete (CNCs) in their employment contracts? To answer this question, we collected a random sample of nearly 1000 CEO employment contracts for 500 companies randomly selected from the S&P 1500 for the time period 1996 to 2010. Our main findings are very revealing. First, our analysis shows that CEO’s are less likely to have CNCs in their employment contracts if the contracts are being enforced in jurisdictions that do not permit strong CNC clauses. Thus, contracts that are likely to be enforced in California are much less likely to include non-compete clauses as its state courts will not enforce those provisions. Second, there is a significant trend toward greater usage of CNC clauses in CEO employment contracts over time. This suggests that employers are more aware than ever of the importance of using CNC clauses and confirms other scholars’ assumptions that, at least in one context, these clauses are used increasingly by employers. Third, there is strong path dependence in the use of CNC clauses: if a company used one in a prior CEO employment contract, then it is much more likely to insist on one in a later contract. Next, longer term contracts are more likely to have CNC clauses than short term contracts. This is likely because the firm has more firm specific investment in CEOs that stay for longer periods. Finally, we find that more profitable firms are more likely to use noncompete provisions in their CEO’s employment contract suggesting that for these firms the risk of harm from a departing CEO may simply be more acute than with other firms.

Keywords: Covenant, Employment contract, CNC, noncompetes