Noncompete Agreements and the Welfare of Consumers

Abstract

Employee spinoffs may harm incumbent firm owners for two reasons: first, they increase competition in relevant product markets, potentially decreasing rents associated with market power. Second, the threat of an employee spinoff may prevent a firm owner from making costly, productivity-enhancing investments in their workers. Noncompete agreements (NCAs) solve both problems. From the perspective of a consumer, NCAs may increase prices by decreasing competition, but the investments made by firm owners have the potential to mitigate competitive harms. We develop a model which formally demonstrates this tradeoff to assess the impacts of NCA policy on consumers, and discuss when a ban on NCAs is most likely to be beneficial for consumers. We show that the competitive environment, the nature of investment pass-through, and the benefits of investment play large roles. Counterintuitively, increased benefits of costly investments have the potential to harm consumers, such that industries where NCAs are most important to firms may also be those where harm is greater. Finally, we draw two analogies between NCAs and antitrust (merger analysis and pay-for-delay agreements) and show how insights in those areas may inform NCA policy.

Keywords: Noncompete agreements, Entrepreneurship, Employee Spinoffs, Antitrust, Consumer Welfare

JEL Classification: J41, J53, K21, L26, L41