Goodbye to noncompete agreements? What the FTC ruling could mean for workers and businesses

In a decision that could free millions of workers to quit jobs and join competitors or form their own companies, the Federal Trade Commission voted Tuesday to ban noncompete agreements. These contracts, which are widespread throughout industries, prevent employees from leaving a company to join a competitor or from forming a competing firm of their own.

About 1 in 5 American workers, from minimum-wage employees to CEOs, are bound by noncompetes, according to the FTC. The new regulations, set to take effect in August, would lead to wage increases totaling $300 billion per year, the agency said.

In its ruling, the FTC cited research co-authored by Tony Tong, professor of strategy and entrepreneurship in the Leeds School of Business, which found that not only do noncompete agreements limit worker mobility, they can lead to economic concentration and reduced competition. On the flipside, banning noncompetes should increase innovation and entrepreneurship since workers and ideas can more easily move among companies.

CU Boulder Today sat down with Tong, also the chair of Leeds' Strategy, Entrepreneurship and Operations Division, to discuss the impact of the FTC's decision on employees and businesses.

What does this ruling mean for workers?

It's a big win, especially for workers who earn a lower salary but have signed noncompete agreements, because their mobility was unnecessarily restrained by such agreements. It's important to bear in mind that noncompetes are not just used for the highest-paid executives; they're used very broadly, even in Colorado, which has a relatively relaxed stance. Unlike highly paid executives who have bargaining power when it comes to negotiating with employers, rank-and-file workers don't have a lot of choices and often have to sign the agreement to maintain employment, especially after they've turned down other offers. A lot of employees don't know that they need to sign one until after they've accepted a job offer and walked into the workplace the first day. And if you're an average worker, you can't walk away at that point.

There's a small downside, though. When employers are able to enforce noncompete agreements, they should be more willing to invest in training and give employees the knowledge related to the company and the industry. Now they may be more reluctant to do that for new employees, for whom that kind of training is very important. The burden of receiving that training might be shifted a bit more to the employees themselves.

What will the impacts be for businesses?

Certain industries like finance and biotech will be especially unhappy because proprietary information or knowledge is key to their success. Larger firms also don't like it; they want their employees to be with them for a long time. Their argument is that noncompetes protect their proprietary information, and with enforceable noncompetes, they're more willing to invest in employees. The FTC's counterargument is that larger firms could use other means to protect proprietary information like nondisclosure agreements, and every state has a trade secret law. You don't need to go so far as limiting someone's mobility to protect your proprietary information.

In general, though, banning noncompete agreements is good news for small businesses. It's much easier for them to hire new employees, and it's good for entrepreneurship. Venture capital firms seem to be reacting positively because they invest in startups.

Your research explores how noncompete agreements affect the broader economy. What were your findings?

The research, which was led by a then-PhD student at Leeds, Kenneth Younge (who was a faculty member at Purdue University's Krannert School of Management when the paper was published), showed that when Michigan accidentally changed its law to enforce noncompetes, the rate of mergers and acquisitions increased. Acquirers saw companies based in Michigan as more valuable in the short run, because these companies could "trap" their employees for some time. M&As can lead to market concentration. However, related research also shows Michigan's noncompete enforcement led many knowledge workers to move to other states later.

Looking ahead, what other outcomes are possible from this ruling?

A lot of organizations are suing the FTC, like the U.S. Chamber of Commerce, but these suits could take a long time to get through the system.

When the ruling goes into effect, I anticipate seeing more employees switching jobs, though not a big surge. They will be less restrained for sure, but people move jobs for many reasons other than noncompetes. Companies too will be digesting and taking other measures to retain employees. They can do a lot of other things to protect proprietary information. And even if one or two employees leave, it's not going to cause a lot of damage to the company unless the whole team is poached.

The FTC's rule makes sense in my opinion. Noncompetes have often been used by companies strategically for reasons other than protecting proprietary information. And some companies are found to be abusing the use of noncompetes, for example by asking new recruits to sign these agreements only after they have accepted the job and turned down other offers; by using vague language in the agreements to cover unnecessarily broad terms; or by threatening to sue employees even if they leave for good reasons. Also, at the end of the day, I don't think in our free economy you can limit people's movement. Employees have the right to seek a higher wage and move to the company they want to work for.

Overall, this is good news for seniors graduating from universities. Especially in a place like Colorado, we have a dynamic economy, and startups are emerging every day, creating a diverse set of opportunities young employees should take advantage of to get the experiences that will benefit their careers.

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