Noncompetes Help Acquiring Companies Retain Workers, But Productivity Falls

Innovators held by contracts produce fewer patents for new owners, study suggests

If you’re building a career through job changes, there’s a good chance a potential employer will demand you sign a noncompete contract to limit where and when you can work if you leave the company. Some 160 million U.S. workers have at some point signed one as a condition of employment, for just about every kind of job imaginable, according to the U.S. Government Accountability Office. 

Here’s a detail to consider before joining that crowd: If your employer is acquired or merged, a noncompete can bind you to a company you never intended to work for. New owners quite likely will assume the rights you signed over to the original employer. In fact, the acquirers probably paid a premium for that forced retention of company talent. Your lack of options to leave the job is considered a bonus to the buyer, even if you’re not a great fit for the new team.

What Happens to Your Noncompete Post-Acquisition?

UCLA Anderson’s Dongryeol Lee, a Ph.D. candidate, explores the fallout of these sometimes awkward post-acquisition entanglements. In a working paper, he observes that noncompetes at acquired firms significantly lower employee exits when the new bosses take over. But, Lee’s data suggests the contract-bound employees become substantially less productive, especially if they were high achieving innovators under previous ownership. 

Across the country, the terms of noncompete agreements aim to bar employees from leaving a job to work for a competitor or to start their own companies and compete, usually for a year or more. The restrictions typically are limited to a geographic area, which may cover a radius of a few miles from the company or an entire city or state. 

Color Coded Level of Enforceability of Noncompetes By State

However, enforcement of these contracts varies widely by state. At the extremes, Massachusetts courts often hold employees liable for violating their noncompetes. California courts don’t recognize the contracts at all. Courts in other states look at variables like the training received on the job, or the scope of the restricted area, before deciding whether to honor them. The Federal Trade Commission under President Biden moved to ban noncompetes entirely, estimating in 2023 that the move would increase American workers’ earnings by between $250 billion and $296 billion per year. Under President Trump, the FTC put that move on hold. There is also strong evidence that non-competes reduce overall economic activity.

In his research, Lee studied 301 mergers and acquisitions where each target firm employed workers in multiple states with varying levels of noncompete enforcement. (The target employee sample was 513,847). For each transaction, he compares reactions from the company’s employees in states with strong contract enforcement to those in states with less enforcement. For the 105 transactions involving patent-producing companies, he also looks at how the value of patents produced by the 7,600 target employees changed by state after new ownership.   

Employees from states with the strictest enforcement were 11% less likely to depart post-merger than those in states with no enforceability, Lee observed. In the year after new owners arrived, the value of patents produced by employees fell as the likelihood of noncompete enforcement rose, he also observed.

“Moving from no enforceability to the strictest enforceability would result in approximately a 40% decline in the number of patents, a 30% reduction in (patent) citations and patents that are worth 60% less in market value,” Lee writes. He estimates that removing noncompetes could have resulted in 600 additional patents worth about $10 billion for the year, a roughly 26% gain relative to current post-acquisition levels.

Some Innovators Stick Around, Perform Well

The biggest drops in productivity were observed among contract-restrained workers who were top patent producers under previous management. Output of team-based collaborators, as well as innovators whose skills are very specific to the target company, appear less affected by noncompete contracts. Their departure rates and patent productivity are more stable after ownership changes, the study suggests.

While the noncompetes help retain employees who buyers want to keep, they also trap employees who are not good fits for the new team, Lee notes. These employees sometimes negotiate out of their noncompetes, but these releases are rare. Buyers have compelling reasons to keep even mismatched talent, including to prevent competing companies from using their skills, Lee writes. The effects of noncompetes he documents in the study — higher retention rates paired with large drops in productivity — were heightened among companies in particularly competitive industries. 

The study results, as Lee notes, rely on the assumption that employees in high enforcement states are likely to be working under noncompetes at each merger. He did not have access to actual contracts and, therefore, couldn’t confirm who had actually signed. He notes several robustness checks aimed at addressing this and other limitations in the data.