Do Non-Compete Covenants Influence State Startup Activity? Evidence from the Michigan Experiment

Abstract

This paper examines how the enforceability of employee non-compete agreements affects the entry of new establishments and jobs created by these new firms. We use a panel of startup activity for the U.S. states for the period 1977 to 2013. We exploit Michigan’s inadvertent policy reversal in 1985 that transformed the state from a non-enforcing to an enforcing state as a quasi-natural experiment to estimate the causal effect of enforcement on startup activity. Our findings offer little support for the widely held view that enforcement of non-compete agreements negatively affects the entry rate of new firms or the rate of jobs created by new firms. In a difference-in-difference analysis, we find that a 10 percent increase in enforcement led to an increase of about 1 percent to about 3 percent in the startup job creation rate in Michigan and, in general, to essentially no change in the startup entry rate. Extending our analysis to consider the effect of increased enforcement on patent activity, we find that enforcement had differential effects across technological classifications. Importantly, increased enforcement had a positive and significant effect on the number of quality-adjusted mechanical patents in Michigan, the most important patenting classification in that state.

Keywords: Startup activity, non-compete agreements, regional economic growth

JEL Classification: O30, O38, R11