Screening Spinouts? How Noncompete Enforceability Affects the Creation, Growth and Survival of New Firms

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Author Information : Natarajan Balasubramanian (Whitman School of Management, Syracuse University)
Evan Starr (Smith School of Business, University of Maryland)
Mariko Sakakibara (Anderson School of Business, UCLA)

Year of Publication : Management Science (Forthcoming)

Summary of Findings : The study examines how the enforceability of noncompete agreements affects entrepreneurship, and finds that while stricter enforceability reduces the entry of within-industry spinouts, those spinouts that are formed tend to be larger and better-performing, consistent with stricter enforceability screening out poorer quality entrants from the market.

Research Questions : How does the enforceability of noncompete agreements affect entrepreneurship?

What we know : Noncompete agreements are widely used by U.S. businesses to restrict potential dissemination of valuable knowledge to competitors. However, they also make it harder for employees to leave their employers. From an entrepreneurship perspective, this particularly affects employees who want to leave their employers and form competing startups. Hence, there is an intense, ongoing debate about whether noncompete agreements should be enforced or not by courts. Eight states in the last three years have sought to join California and North Dakota as the only states to ban these agreeements. This study aims to provide the first direct empirical evidence on this question.

Novel Findings : We find stricter enforceability is associated with fewer within-industry spinouts, but relative to spinouts formed outside the parent firm's industry, within-industry spinouts that are created tend to start and stay larger, are founded by higher-earners, and are more likely to survive their initial years. In contrast, we find no impact on entry of spinouts formed outside the parent firm's industry and a negative effect on size and short-term survival. These findings are consistent with stricter enforceability screening out lower-quality entrants from the market.

Abstract : This paper examines how the enforceability of noncompete covenants affects the creation, growth and survival of spinouts and other new entrants. The impact of noncompete enforceability on new firms is ambiguous, since noncompetes reduce knowledge leakage but impose hiring costs. However, we posit that enforceability screens formation of within-industry spinouts (WSOs) relative to non-WSOs by dissuading founders with lower human capital. Using data on 5.5 million new firms, we find greater enforceability is associated with fewer WSOs, but relative to non-WSOs, WSOs that are created tend to start and stay larger, are founded by higher-earners, and are more likely to survive their initial years. In contrast, we find no impact on non-WSO entry, and a negative effect on size and short-term survival.

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Natarajan Balasubramanian

Natarajan Balasubramanian

Professor Balasubramanian is an associate professor of management whose research interests are in competitive analysis, organizational learning and innovation.
Natarajan Balasubramanian
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