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Thursday, May 23, 2024

Opinion | The Mostly Persuasive Logic Behind the New Ban on Noncompetes

BusinessOpinion | The Mostly Persuasive Logic Behind the New Ban on Noncompetes

The Federal Trade Commission used two very different rationales to get to its near-total ban this week on noncompete agreements. One of them is a no-brainer. The other is provocative but not completely obvious. I guess I’d call it a brainer.

As you may have read, the F.T.C. commissioners on Tuesday voted 3 to 2 on a final rule against noncompete clauses in employment contracts, which limit the ability of an employee to quit and immediately go work for a rival. The commission determined that they are an “unfair method of competition.” The rule takes effect 120 days after its publication in the Federal Register, unless a court blocks it before then.

The easy prong of the ban for the F.T.C. to justify is the one that applies to nurses, hairdressers, truck drivers — actually, every kind of worker except for senior executives. For 99 percent of the American work force, the F.T.C. said, requiring workers to sign noncompete agreements as a condition of employment is “coercive and exploitative conduct.”The agency’s 570-page ruling cites articles in The Times and The Wall Street Journal in which workers came forward to say, in the F.T.C.’s words, that noncompete agreements “derailed their careers, destroyed their finances, and upended their lives.” I agree. I wrote a piece in 2021 titled, “Why Are Fast Food Workers Signing Noncompete Agreements?”

But the “coercive and exploitative” rationale doesn’t work for senior executives, who aren’t so easy to coerce or exploit. They’re more likely to have lawyers look over contract offers. They typically have some power in the employment negotiation and know how to use it. Many won’t sign a noncompete agreement unless they get something in return, such as a sweetened pay package.

The F.T.C. defined senior executives as people earning more than $151,164 per year who are in a “policy-making position,” and estimated that fewer than 1 percent of workers meet the description. Under the rule, existing noncompetes for senior executives can remain in force but most new ones are banned. The rule doesn’t apply to clauses that are related to the sale of a business.

For noncompetes involving senior executives, the F.T.C. fell back on another argument, which is that the agreements are “restrictive and exclusionary conduct” that harms competition in product, service and labor markets. (The F.T.C. says that this second argument also applies to other workers, but for them I think it’s overshadowed by the “coercive and exploitative” argument.)

This is a bit subtle. It requires you to think of the employer and the senior executive as being in cahoots rather than fighting each other. Together they cook up a noncompete that rewards the executive for agreeing to deprive other potential employers of her or his talents, and depriving the customers of those other companies of potentially better products and services. In economists’ terms, noncompete signatories are “maximizing their bilateral surplus” at the expense of others.

The logic is that the company that can’t hire the executive might have better growth prospects, so holding it back is bad for society as a whole. Or, after leaving the old employer, the executive has to be (wastefully) inactive for six months or so to wait out what finance people call the garden leave. Or the new employer has to pay a large sum to buy out the noncompete clause — again, socially wasteful.

“There can be sizable gains from restricting these contracts,” Liyan Shi of Carnegie Mellon’s Tepper School of Business wrote in a 2023 article in the journal Econometrica.

As I said, this is an interesting and even persuasive argument. But it’s not simple to make.

“If this becomes the approach,” Sean Heather, the senior vice president for international regulatory affairs and antitrust at the U.S. Chamber of Commerce, asked me, will any contract that doesn’t take into account the interests of third parties be “no longer viable?”

Charles Tharp, a professor of the practice at Boston University’s Questrom School of Business, said that while banning the noncompete might benefit a future employer, it harms the current employer, so there’s no net benefit; it’s a wash.

But two other economists I contacted disagreed with Tharp and Heather. Evan Penniman Starr, an associate professor at the University of Maryland’s Smith School of Business who is an expert on noncompete agreements, wrote to me that governments shouldn’t always put third parties first, but shouldn’t ignore them either, citing smoking bans to protect third parties from secondhand smoke. As for Tharp’s point, he wrote, “If match quality is higher at the subsequent firm, it is not a wash. It’s an efficient move that would destroy value if it wasn’t made.”

Sandeep Vaheesan, the legal director of the Open Markets Institute, emailed me that companies could still retain senior executives through higher pay packages and fixed-term contracts. Noncompetes are a “stick,” he wrote. “Public policy should encourage employers to use carrots instead. The F.T.C. noncompete ban does exactly that.”

Vaheesan also sided with the F.T.C.’s argument that companies have other ways to protect themselves when a key employee leaves, such as trade secret protection and agreements that prohibit people from soliciting customers of the companies they used to work for.

There’s precedent for taking into account the interests of third parties, Starr told me. He cited an American Bar Association model rule on professional conduct, which forbids restricting attorneys from working elsewhere, not only because it harms the attorney but also because it “limits the freedom of clients to choose a lawyer.”

The strongest evidence against noncompete agreements is that Silicon Valley has thrived even though — or maybe even partly because — the state of California has long banned noncompete agreements in most circumstances, under a law passed in 1872. The prohibition does not seem to have discouraged companies from sharing valuable inside information with employees who might leave. And it has enabled the germination of ideas as people flit from company to company like pollinating honeybees.

“Noncompetes are a pain in the neck for us,” Dr. Stephen DeCherney, who is the chair of New York-based Helios Clinical Research, told me. “Overall I won’t be sorry to see them go.”

Still, this is going to be messy for a while. The U.S. Chamber of Commerce has filed a lawsuit against the F.T.C. to block the rule, arguing that the agency doesn’t have the power to issue such a ban and that even if it did, a categorical ban isn’t lawful. Eugene Scalia, who was President Trump’s secretary of labor for a year and a half, also filed a lawsuit, this one on behalf of Ryan LLC, a tax services firm in Texas whose chief executive, Brint Ryan, is a Republican donor who has advised Trump.

Even if the F.T.C. wins on the legality of its rule, enforcing it is going to be tricky. Let’s say a company gets rid of its noncompete clause, but it imposes a nondisclosure agreement that’s so broad and strict that it “has the same functional effect” of preventing someone from taking a job elsewhere. According to the F.T.C., “such a term is a noncompete clause under the final rule.”

Arguing over what’s “the same functional effect” is going to keep a lot of lawyers busy. Same for nonsolicitation agreements and trade secret protection. “‘You can’t work for a competitor for a year’ is a pretty clear rule; ‘you can’t use our secrets at a competitor’ will mean more lawsuits,” Matt Levine, a columnist for Bloomberg Opinion, wrote Wednesday.

I admire the F.T.C. for looking at the entire economic landscape in evaluating the pros and cons of noncompete agreements, not just the interests of the employer and employee. It’s a bold step, though.

You wrote that most right-to-work laws were passed in the 1940s and 1950s, when Southern states were solidly Democratic. True, but in the ’60s after the passage of the Civil Rights Act the Southern Democrats were wholly absorbed by the Republican Party. Right-to-work is an anti-union strategy implemented by the same power elite that discouraged workers in this most recent vote. Their failure is significant. When Southerners start thinking for themselves, I view that as a hopeful development.

Rebecca Bartlett
Brattleboro, Vt.

I’m a 47-year union member enjoying my retirement with an old-fashioned, union-negotiated pension and lifetime medical coverage. As those Volkswagen workers told you, to a certain degree, it doesn’t matter who the president is when it comes to what union members are paid. But it does matter to all employees who the president appoints to critical agencies such as the National Labor Relations Board, the Occupational Safety and Health Administration, the Equal Employment Opportunity Commission, and many more. Those agencies have real day-to-day impact on workers’ lives and futures.

Jim Griffin
King George, Va.

Concerning your newsletter on Donald Trump’s economic agenda: He is clearly advocating an isolationist strategy. One does not have to look far to see that isolationism is a dead-end street. Is there anything to love about North Korea’s economy? How about Brexit?

Bob Kerst
San Francisco

“Got no diamond, got no pearlStill I think I’m a lucky girlI got the sun in the morning and the moon at night”

— Irving Berlin, “I Got the Sun in the Morning” (1946)

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