Human Capital Briefs

Aggressive Talent Wars Are Good for Cities

November 01, 2013

California is often ranked among the world’s most inventive regions. But most observers miss one of the major reasons why: the absence of non-compete agreements.

Barring non-competes is one of California longstanding strong talent mobility safeguards. Unlike most other states in the United States, but more like innovative Western European countries like Germany, the Netherlands, and Sweden, California has rules about allowing job mobility within markets. The California Business Code voids all non-competes agreements between businesses and their employees, while the California Labor Code restricts the ability of corporations to require their employees to pre-assign all inventions, even if unrelated to the job, during the course of employment.

California courts have been so adamant about enforcing the state’s prohibition of non-competes, they’ve held that companies who do not hire or promote talented employees who refuse to sign a non-compete (which would be void anyway if taken to court) are liable in tort and should be subject to punitive damages. They’ve even refused to enforce non-competes that were signed in other states, announcing them contrary to state policy.

Conversely, Boston’s Route 128 tech beltway has not flourished the way Silicon Valley has, in part because of restrictive non-compete agreements. Non-competes have contributed to the more rigid, vertically integrated, and prone to insourcing ethos of Boston’s high tech region.

California’s lack of non-compete agreements is the reason Marissa Mayer could assume the position of CEO at Yahoo! immediately upon leaving its direct competitor, Google. And, as it turns out, it’s the reason California’s cities are some of the most innovative in the world – and provides a model for fueling innovation and economic growth elsewhere.

Job-hopping at all ranks is part of the California knowledge economy, but the policy spills over to the industrial culture too, creating a culture of openness, movement, and networking, where companies know that the talent wars are a repeat game. Even though Californian companies face a higher risk that their best talent will leave, they also recognize the long-term benefits of talent mobility. And industry leaders learn to view the departure of employees not only as a loss (because of course there is a loss) but also as potential gain, in which former employees may eventually return, bringing new skills back with them.

Although most companies are keen to reduce turnover, a stunning number of new studies demonstrate how high employee turnover actually contributes to economic growth. Research by Matt Marx (Sloan) and Lee Fleming (Berkeley) finds that after Michigan began to allow non-compete agreements, the state experienced a brain drain of its best talent. Many decamped for California, especially those inventors with the most-cited patents.  In another recent study on VC investment and non-competes, Yale SOM professors Samila and Sorenson conclude that mobility restrictions not only impede entrepreneurship and start-up ventures, they slow the overall economic growth of a region. Studying a decade’s worth of data on over 300 metropolitan areas in the United States, including patent filings, levels of VC investment, and level of entrepreneurships, the study finds that relative to states that enforce noncompetes, an increase in venture capital in states that either void or restrict non-competes has significantly stronger positive effects on regional patenting rates, start-up rates, and job growth. In response to an identical influx of local VC, states that do not enforce non-competes experience twice the increase in patents, double the birth of new companies compared to states that enforce them, and three times the employment growth of non-compete enforcing states, benefiting not only the start-up segment of a region but also incumbents.

There is also a motivational aspect in allowing people to leave and encouraging them to stay using positive, rather than negative, incentives. In recent behavioral studies, my collaborator On Amir (Rady UCSD) and I find that participants bound by non-compete agreements and other post-employment restrictions did not perform as well and were less motivated to stay on task than those unbound. Participants in our experiments were more likely to quit the task and to make errors when they were asked to sign non-competes. Garmaise (Anderson UCLA) finds that non-compete enforcement strongly reduces executive mobility and shifts compensation from bonuses and performance-based pay to a heavy reliance on a fixed salary.

In other words, performance carrots work better than restrictive sticks. Think about it: human capital is not a static resource in the way real estate or building materials serve a construction company.  Human capital is both a resource and a living subject who makes constant judgments, decisions, and choices about the quantity and quality of outputs.

If you can’t legally restrict your talent from leaving, you’d find better more motivating approaches to retain it.

 

This blog first appeared on Harvard Business Review on 10/04/2013.

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