Innovation and Knowledge Protection: How Firms Respond to a Loophole in Non-Compete Enforcement
37 Pages Posted: 2 May 2018
Date Written: April 30, 2018
We examine how firms manage innovation processes and outcomes to protect themselves against knowledge leakage caused by employee mobility. In 1998, the California Court of Appeal ruled that non-compete agreements (“non-competes”) signed by an employer and an employee outside of California are not enforceable in California. This court decision created a loophole for non-California firms in their enforceability of non-competes as employees bound by non-competes could now move freely to California firms. We find that this California-driven loophole significantly affected knowledge management of firms outside California which had been enforcing non-competes. Internally, firms increased patenting without increasing R&D input. This implies that firms rely more on strategic patenting, rather than secrecy, when the risk of employee separation increases. Firms also changed their external relationships. On the one hand, firms decreased alliances, particularly with California firms, in fear of potential employee movement. On the other hand, firms relatively increased acquisitions of California firms compared to non-California firms in their M&A portfolio. The results suggest that alliance and acquisition provide opposite incentives and are less substitutable for knowledge protection purposes.
Keywords: Innovation Strategy, Knowledge Protection, Employee Mobility, Non-Competes
JEL Classification: O32, J61, K31, G34
Suggested Citation: Suggested Citation