For Official Use DSTI/EAS/STP/NESTI/TIP(2012)10 - OECD

For Official Use DSTI/EAS/STP/NESTI/TIP(2012)10 Organisation de Coopération et de Développement Économiques Organisation for Economic Co-operation and Development 06-Dec-2012 ___________________________________________________________________________________________

English - Or. English DIRECTORATE FOR SCIENCE, TECHNOLOGY AND INDUSTRY COMMITTEE FOR SCIENTIFIC AND TECHNOLOGICAL POLICY

Working Party of National Experts on Science and Technology Indicators Working Party on Innovation and Technology Policy

KNOWLEDGE FLOWS AND THE MOBILITY OF SKILLED EMPLOYEES: AN INTERNATIONAL PERSPECTIVE ON THE ROLE OF NON-COMPETE AGREEMENTS AND THEIR LEGAL ENFORCEMENT

13-14 December 2012

This report represents a contribution to the DSTI project on Knowledge Networks and Markets. TIP delegates are invited to consider discuss the report's preliminary findings and the relevance of non compete agreements (NCAs) to their national innovation systems.

Contact: Mr. Fernando GALINDO-RUEDA (OECD/STI/EAS); Tel: (+33-1) 45 24 87 49 E-mail: [email protected]

JT03332375

Complete document available on OLIS in its original format This document and any map included herein are without prejudice to the status of or sovereignty over any territory, to the delimitation of international frontiers and boundaries and to the name of any territory, city or area.

DSTI/EA

S/STP/NESTI/TIP(2012)10

For Official U

se

English - O

r. English

DSTI/EAS/STP/NESTI/TIP(2012)10

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KNOWLEDGE FLOWS AND THE MOBILITY OF SKILLED EMPLOYEES: AN INTERNATIONAL PERSPECTIVE ON THE ROLE OF NON-COMPETE AGREEMENTS AND

THEIR LEGAL ENFORCEMENT

TABLE OF CONTENTS

EXECUTIVE SUMMARY ............................................................................................................................ 3

KNOWLEDGE FLOWS AND THE MOBILITY OF SKILLED EMPLOYEES: AN INTERNATIONAL PERSPECTIVE ON THE ROLE OF NON-COMPETE AGREEMENTS AND THEIR LEGAL ENFORCEMENT ........................................................................................................................................... 5

1. Introduction ............................................................................................................................................. 5 2. Knowledge flows and innovation: the role of employee mobility .......................................................... 7

How important are new employees as innovation knowledge sources? .................................................. 8 What do we know about skilled employees’ mobility? ......................................................................... 11 Restrictions to mobility and potential implications ............................................................................... 16

3. The use and legal enforcement of non-compete agreements in employment contracts ........................ 18 The use of non compete agreements ...................................................................................................... 18 The enforcement of non-compete agreements ....................................................................................... 21

United States ...................................................................................................................................... 22 International evidence ........................................................................................................................ 23

4. The impact of enforcement rules for non compete agreements............................................................. 29 The enforcement of non compete agreement and job mobility ............................................................. 29 The impacts on enterprise, venture capital and innovation .................................................................... 31

Exploring the impact of changes in US states on R&D and patents .................................................. 34 5. Implications for policy analysis and concluding remarks ..................................................................... 35

Policy implications ................................................................................................................................ 36 Implications for future measurement and research work ....................................................................... 39 Concluding remarks ............................................................................................................................... 40

REFERENCES ............................................................................................................................................. 40


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EXECUTIVE SUMMARY

• There is widespread consensus about the importance of knowledge diffusion as an enabler of innovation and the key role played by the mobility of highly skilled employees in facilitating such flows. Employee mobility is widely held to be important not only for enhancing labour market efficiency and productivity, but also as a conduit for knowledge flows across firms and organisations. Employee mobility can thus be described as the engine of what is allegedly the most important market for knowledge, i.e. the labour market for highly skilled individuals.

• The available empirical evidence confirms the importance of new personnel as a key source of information for innovation. The literature on mobility finds evidence of spillover effects from mobility. However, the range of possible mechanisms and impacts is particularly wide and the net impacts on innovation and economic performance can be ambiguous. A high degree of employee mobility implies a high depreciation rate for investments made by firms in knowledge that is embodied in employees, as well as a potential loss of competitiveness vis à vis competitors who might recruit former employees.

• Employers have developed strategies aimed at protecting their business interests. While these often reward loyalty, they can impose a number of restrictions on employees considering leaving the firm, requiring them to agree not compete with the employer upon departure. These covenants are typically described as non-compete agreements (NCAs).

• The potential role of NCAs was briefly alluded to in the OECD Innovation Strategy (OECD, 2010), as it considered the role of regulatory burdens in preventing entrepreneurship and innovation. The use of NCAs appears to be more prevalent than commonly thought, judging by evidence from ad hoc surveys and litigation statistics from the United States. Litigation on non-competes appears to be increasingly associated with disputes regarding trade secrets.

• From an international comparative perspective, attention to legislation on NCAs in employment contracts and its impact has been limited and often restricted to analysis by legal practitioners. Most of the policy debate and available empirical evidence have been, to this date, largely US-centred, likely due to the combined effect of employee mobility being significantly higher than in many other OECD countries and the possibility to study variation across states, thus enabling like-for-like comparisons.

• An experimental investigation of legal sources aimed at identifying how countries differ in their enforcement of NCAs has revealed some marked inter-country differences across countries, as large as those found across different states within the United States of America. An initial attempt has been made to codify and measure the extent to which different national jurisdictions enforce NCAs, constructing a very preliminary indicator. The enforcement indicator is based on a number of features, which include the breadth of the employers’ protectable interest (e.g. beyond trade secrets), the use of time and regional limitations, the special treatment of certain “knowledge workers”, the required compensation to an employee prevented from competing, the ability of courts to modify NCAs to render them applicable, and the possibility of awarding injunctions, to cite a few.

• The results indicate that in addition to states like California, countries such as India, Israel, Mexico, Luxembourg and the Russian Federation rarely enforce NCAs. Chile and a number of “common law” countries such as United Kingdom, Australia, New Zealand have regimes in which the enforcement of NCAs is permitted but only under rather restrictive circumstances. Most European continental countries have regimes which enable a more permissive approach towards NCAs, although their


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statutes often require the payment of some compensation to the employee that is subject to such a covenant and precluded from working for a competitor.

• The enforcement of NCAs is evolving through legislative reform and case law arising from decisions by courts. The Slovak Republic reformed its system late in 2011 to allow the use of NCAs. Conversely, Israel’s high court came to a decision in 2006 which effectively banned most types of NCAs.

• The empirical literature on NCAs suggests that NCAs are often used strategically for purposes other than preserving trade secrets, either by reducing employee mobility or by leading them to take career detours away from their area of specialisation. The literature also finds evidence that NCA enforcement reduces mobility across firms within the relevant jurisdiction, while it incentivises key knowledge workers –such as inventors– to take up jobs in jurisdictions where such clauses are not enforceable.

• It has been argued that barriers to mobility can be more detrimental to the growth of emerging technology areas when these are characterised by high modularity and a lack of a dominant design. There are plenty of anecdotes linking the ban on NCAs in California and the emergence of the ICT industry through the departure of key employees for large incumbent firms. While it may be tempting to draw conclusions from this and the fact that successful ICT clusters are found not only in California but also in other jurisdictions like India and Israel where NCAs are not significantly enforced, there is no firm evidence that NCAs are the primary reason for the observed clustering patterns in this industry.

• The evidence on the impact on enterprise and innovation is by no means clear cut. It has been argued that employees would be less willing to consider leaving their enterprise and go to work for start-ups if NCAs are enforced. However, in the absence of NCAs, highly liquid, incumbent firms may poach away key staff from disrupting innovating companies.

• It is still unclear whether the enforcement of NCAs is an underappreciated policy tool, or whether its real significance is minor in comparison to other barriers to mobility and knowledge flows. This document considers a number of possible avenues for improving the evidence base, including the addition of possible questions in business innovation surveys and surveys of doctorate holders and other human resources for science and technology.

• From a policy perspective, the study of NCAs combines elements of labour, competition, IP and contract law. Policy decisions can have wide ramifications. A reduced enforcement of non-competes can give rise for example to increase litigation regarding trade secrets, or encourage firms to adopt other anti-competitive practices that restrain the flow of employees. For example, there have been a number of recent prosecutions by the U.S. authorities against a number of high profile IT firms who were accused of conspiring to not poach each others' employees. In other, smaller countries characterised by low levels of geographic mobility and one or very few firms operating in a given sector, non poaching agreements may be easier to implement away from the attention of anti-trust authorities.

• In the light of the outstanding evidence gaps, policy makers could being to focus, within their current legal systems, on identifying the key informational and market power asymmetries that may distort incentives to move jobs and invest in innovation, looking in particular at how the use of NCAs and the decisions made by courts impact on key knowledge workers. This is likely to require a multidisciplinary approach which combines economic, sociological and legal perspectives.


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KNOWLEDGE FLOWS AND THE MOBILITY OF SKILLED EMPLOYEES: AN INTERNATIONAL PERSPECTIVE ON THE ROLE OF NON-COMPETE AGREEMENTS AND

THEIR LEGAL ENFORCEMENT

1. Introduction

1. There is widespread consensus on the importance of knowledge diffusion as an enabler of innovation and on the key role played by the mobility of highly skilled employees. Employee mobility is widely held to be important not only for enhancing labour market efficiency and productivity, but also as a conduit for knowledge flows across firms and organisations. It can be more efficient for companies to identify and recruit an individual with a given skills profile rather than attempt to acquire the knowledge in other ways. Entrepreneurs in fast growing new firms have been found to draw in many cases from ideas encountered in previous employment (Bhidé, 1994 and 2000).

2. Employee mobility can be a significant concern for employers, as resources that have been invested over time into their training can be rapidly and irreversibly lost. Furthermore, such loss may be compounded if those skills are eventually used by direct competitors who did not incur the required upfront investment. There is widespread evidence that a significant part of the value of modern companies resides not in the value of the physical assets it holds, but in the knowledge-based assets the company can command and put to practical use. While some of these intellectual assets can be ascribed to well-identified, codified and separable knowledge protected through formal property rights, much of a company’s value increasingly rests in knowledge held individually and collectively by its employees, as reflected by commercial connections held by sales personnel, non-patentable technical know-how embodied in the minds of technical staff, and organisational and business model knowledge as embedded in its senior management. The departure of specific individuals can thus cause a major disruption to a company’s stock of knowledge capital and hinder its ability to successfully implement new innovations or realise value from them.

3. A number of changes have made the risks of employee mobility more apparent to incumbent employers. The flattening of organisational structures has allowed many employees to have access to critical and sensitive business information which in the past would have been held by a small number of people. Nowadays, more employees carry out their work outside the direct oversight of supervisors and the widespread use of ICTs enable information to be easily copied and transferred. Traditional employee loyalty values associated to notions such as “job for life” are being eroded through increased competition in domestic and international product markets, while the outsourcing and off-shoring of jobs contributes to employees taking a more open view of their likely future career paths. Prior to the economic downturn, mobility -and the threat of moving jobs- became a credible and powerful mechanism for seeking pay rises amongst many professions in high demand. While the economic downturn may have led to a slowdown in this trend, it may also have encouraged employees to look for opportunities elsewhere in anticipation of potential dismissals or wage reductions.

4. In response to the dilemma posed by the risks of prospective employee mobility, employers have developed strategies and incentive mechanisms aimed at protecting their business interests. Employers can reward employee loyalty by tying salary and other benefits to tenure, sharing a stake in the company’s profits with their employees as well as through implicit arrangements. Firms can also impose a number of restrictions on employees wishing to leave the firm, by conditioning the employment offer on non-


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competition with the employer upon an employee’s departure. The use of non-compete agreements (NCAs from now onwards) or clauses in employment contracts, also known as covenants not to compete, or more succinctly, “non-competes”, might be seen as a solution to the impossibility of specifying in contract all possible circumstances that may surround and follow up the departure of an employee, foreclosing potential outcomes that result in adverse outcomes that the company cannot insure itself against through other means.

5. The use of NCAs has been strongly contested since they impinge on individual freedom to carry out a profession and may be too blunt an instrument to protect the economic interests of the previous employer. Contractual barriers to post-employment mobility, even if mutually agreed, are typically frowned-upon by legislators and courts, leading some jurisdictions to effectively ban such agreements or to significantly curtailing their enforcement. Rules concerning the enforcement of NCAs lie at the complex junction of competing interests among various parties and applicable laws and regulations. Employment, contract, competition and intellectual property law issues arise when investigating the balance of social costs and benefits arising from restricting the use of NCAs.

Box 1. The growing interest in non-compete agreements - potential impacts on innovation and entrepreneurship

An increasing body of literature has paid detailed attention to NCAs from an innovation and entrepreneurship perspective (see Marx and Fleming, 2011). The roots of this discussion can be traced back to a discussion on whether rules that ban the enforcement of non compete agreements by courts can be a key part of the cultural and institutional setting that sets the conditions for enterprise and agglomeration economics to flourish in some areas. Saxenian (1996) examined key differences between Silicon Valley and Boston’s Route 128 as part of an investigation into the role of decentralized industrial and innovation systems with comparable technological capabilities. She famously concluded that Silicon Valley’s success at various stages had been related to the tendency of skilled employees to move from company to company, and to more easily apply the knowledge they developed along the way. Gilson (1999) went further by arguing that jurisprudential differences between the state of California, which has banned non-competition agreements by statute since 1872, and Massachusetts, which permits non competition agreements, could have had the probably unintended consequence of making it relatively easier to move jobs (“job-hopping”) in California, thus promoting an entrepreneurial community of technology-based start-up companies. While most observers are willing to agree with the general statement that “knowledge spillovers” provide economic benefits, some authors have counter-argued (Wood, 2000) that venture financing and start-up success has also been prevalent in regions where non-competition clauses are legal, suggesting that regions that enforce these agreements might have developed alternative mechanisms for ensuring labor mobility and the associated knowledge spillovers.

6. The role of employee mobility and the use of NCAs have implications for the design of innovation policy, particularly if national innovation performance is assessed through the prism of a “national innovation system” framework. The potential role of NCAs was briefly alluded to in the OECD Innovation Strategy (OECD, 2010), as it considered the role of regulatory burdens in preventing entrepreneurship as part of its whole-of-government approach to considering the governance of innovation systems governance to ensure that framework conditions are sound and supportive of competition, conducive to innovation and mutually reinforcing. Previous OECD work has looked at the impact of red-tape involved in opening up new businesses and other entry regulations1, bankruptcy laws that impact on the downside scenarios associated with innovation processes, taxation and labour market regulations. Among the latter, most of the emphasis has been on the implications of employment protection legislation2 and features of countries’ social security and pensions systems that sometimes penalise mobility. Migration policies including special visa schemes for qualified workers and postgraduate students are identified as an important lever for promoting international mobility and linkages amongst the highly skilled. 1 . See for example Bassanini and Ernst (2002).

2 . http://www.oecd.org/employment/employmentpoliciesanddata/34846890.pdf


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7. From an international comparative perspective, attention to legislation on NCAs in employment contracts and their impacts has been the sole domain of legal practitioners. Most of the policy debate and available empirical evidence have been, to date, largely US-centred, likely due to the combined effect of employee mobility being significantly higher than in many other OECD countries and the possibility to study variation in enforcement and performance across states. The latter is clearly facilitated by a wealth of data and the fact that US states share a number of common regulatory features (e.g. federal employment legislation) which are more conducive to like-for-like comparisons. This document attempts to fill part of this evidence gap by laying out which countries restrict or favour the use of NCAs in employment contracts. Building on a number of legal sources, it is possible to draw an experimental index to score how permissive different jurisdictions in OECD member countries and observer economies are with respect to such covenants. The results indicate that a non negligible number of countries do not enforce NCAs, while the majority authorise and enforce them to a varying degree, balancing the interests of the former employer and the departed employee in different ways.

8. By looking at the role of NCAs, this document draws a link between the study of barriers to mobility, the importance of knowledge networks and markets, of which the labour market is admittedly the largest, and the incentives for companies to invest in innovation and build up their stock of knowledge-based capital.3 It is structured as follows: Section 2 provides an overview of the evidence concerning the role of employee mobility in driving knowledge flows, laying out the possible trade-offs between mobility and innovation. The purpose of this section is to explain in some detail the possible mechanisms by which any constraints on labour mobility can impact on knowledge flows and innovation, as well as the different data sources that might be used for that purpose. Readers primarily interested in the subject of NCAs may wish to skip section 2 and move straight into Section 3, which deals with the specifics of NCAs and reviews evidence on their use by firms and their enforcement by authorities. It sets out the methodology used for comparing practices across different OECD and observer countries and shows the main results. This is to our knowledge the first time that an attempt has been made to codify international practices on a wide basis for policy analysis purposes. Section 4 reviews some of the existing evidence on the impact of NCAs and their enforcement. It adds to this evidence by carrying out a simple analysis based on US data. Section 5 concludes with a number of policy and analytical implications arising from the evidence reviewed and new results.

2. Knowledge flows and innovation: the role of employee mobility

9. Evidence shows that innovation is not simply a process of converting R&D and other inputs into new products. Rather it is a complex process, unfolding through time, in which capabilities are produced and integrated, and through which learning occurs and knowledge is created, transferred and utilised (OECD, 1997 and 1999). There is widespread consensus about the importance of knowledge diffusion as an enabler of innovation. Knowledge is at the core of innovation and needs to flow effectively so that it can be put to its most efficient and effective use, ensuring that the parties that contribute to its creation and development are rewarded in proportion to their effort and risk incurred. As the growing literature on open innovation states, there are multiple reasons why the organisation in which an invention was created may be worse-placed than others to fully implement it. 3 . This document is concerned with non-compete agreements that apply in the context of employment

contracts and regulate the permissible activities of departing employees following their departure. Restrictions that apply during the employment period are typically stronger and automatically enforced by laws without the need of an agreement other than the employment contract, given a presumption of employee duty. Outside the scope of this document are agreements not to compete which are incidental to the sale of a business (e.g. restricted what the seller can compete with the buyer of the business) and non-compete agreements contained within a shareholder's agreement, where there is not an underlying employment relationship. Also related but outside the scope are specific agreements with employees concerning confidentiality or non-disclosure, employee or client solicitation, to cite some examples.


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10. Human capital plays an essential role facilitating these flows, as knowledge cannot always be commoditised and transferred without the intervening know-how and knowledge embedded in people that facilitate its absorption and usage. For example, Levin et al. (1987) highlighted, in their influential study of flows of technological knowledge, the role of the movement of personnel – specifically, the hiring of R&D employees away from innovating firms – as a key element within a wider range of potential channels of information flows such as licensing, patent disclosures, reverse engineering. This contribution also noted the very close link between the movement of skilled personnel with other forms of information flows involving inter-personal communication (technical meetings, informal conversations, etc.). Hyde (2011) noted that “mobile employees are the best source for spreading lawful, public domain information”. In particular, he argues that rather than trying to learn from scientific and trade journals, conferences and the like, it is easier for firms to hire someone with the relevant expertise.

11. Employee mobility is a phenomenon with wide ranging implications for the study of innovation as it directly impacts on incentives to invest in human capital by firms and employees themselves, entrepreneurship, competition, spatial agglomeration and knowledge flows of multiple types. As it would be far too ambitious to attempt to describe all the relevant literature in this particular document, the focus below is to provide some illustrative examples with the aim of evaluating which are the likely impacts of barriers to employee mobility.

12. The set of institutions that govern the movement of personnel are a key yet often neglected part of the study of national innovation systems. An OECD project on National Innovation Systems carried out in the 1990s was devoted to deepening the analysis on three themes: clusters; innovative firms and networks; and human resource mobility. The work on human resource mobility benefitted from contributions from several countries under Norwegian leadership. OECD (2001) reflected the findings from this work confirmed its importance, among and between the private and public sectors, as a carrier for the diffusion of tacit knowledge, at both national and global levels. Based on new empirical evidence, the project compared the rates and patterns of mobility of high-skilled labour in a sample of OECD countries, and documented the rapid internationalisation of this form of knowledge flow. It also provided guidance for the improvement of a still-fragile statistical infrastructure, given the need for further comparative analysis and policy assessment of this increasingly important factor of innovation performance. This work has been subsequently echoed in the OECD Innovation Strategy (OECD, 2010a) at a policy level; and new indicators were published in the Measuring Innovation monograph (OECD, 2010b) and the OECD Science, Technology and Industry Scoreboard (OECD, 2011b).4 The study of mobility amongst the highest qualified –i.e. the population of doctorate holders- has also been the subject of a joint OECD-Eurostat-UNESCO study (Auriol, 2010).5

How important are new employees as innovation knowledge sources?

13. Business innovation surveys carried out worldwide under the guidelines set out in the Oslo Manual (OECD/Eurostat 2005) have consistently found that the main source of information for innovation typically lies within the business itself or an affiliated company with shared ownership links (e.g. OECD, 2011b). However, standard questions aiming to identify sources of relevant knowledge for innovation tend to miss out on the fact that resources that are internal to the company at the time of reporting might have been sourced from external organisations at the very outset of the innovation process. It is for example not uncommon for companies to hire new managers or researchers to lead new innovation projects, from research to commercialisation, or take leading executive positions within the company itself. Unfortunately there is no widespread information across OECD countries on the extent to which such internal sources of 4 . On the policy side, the topic of researcher mobility is regularly covered in the biennial OECD Science,

Technology and Industry Outlook. www.oecd.org/sti/outlook

5 . See also www.oecd.org/sti/cdh


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innovation are linked to the hiring of new staff. One exception is the Australia Innovation Survey (“Business Characteristics Survey”), which asks business how they “sourced labour for the development or introduction of new goods, services, process or methods” and prompts them for different approaches. 22 percent of firms report the employment of new persons (18% for non graduates) as one of the approaches, compared with 81% for persons within the company, 18% for consultants, and 11% for persons employed by the business’s collaboration partners (Australian Bureau of Statistics, 2010).

Figure 1. Where do ideas for business innovation originate? The role of new employees in New Zealand6

Note: Based on (non exclusive) answers to question: “did this business find any of the following important as a source of ideas or information for innovation?” “New staff” are defined as having been recruited by the firm in the two previous years.

14. More information is available from the New Zealand innovation survey, where a more detailed breakdown of internal sources of knowledge and information is available. Recent results (displayed in Figure 1 above) show that the three most important sources of information for innovating businesses were “existing staff” (70 percent), customers (56 percent) and new staff (48 percent). Existing and new staff are internal sources of knowledge that businesses can draw upon to support their innovation efforts.7

6 . See http://www.stats.govt.nz/browse_for_stats/businesses/business_growth_and_innovation/innovation-in-

new-zealand-2011/ideas-innovation-many-sources.aspx

7 . In addition to what is nowadays the standard question on sources of information for innovation, the first Community Innovation survey carried out in 1993 also contained a question about whether the enterprise had acquired any new technologies during 1992 from sources which included the “hiring of new employees”, alongside “rights to use 3rd party invention rights”, “R&D contracted out”, company acquisition, purchase of equipment, communication with other enterprises (suppliers/customers/competitors). The survey also asked about outward technology flows, including the option to signal the mobility of skilled employees as possible mechanism. Results for France are available in Duguet and McGarvie (2004). Within a sample of 465 manufacturing firms, 37% of firms reported acquiring technology by hiring employees, compared with 30% via patents and licences. 13% reported


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15. Practical considerations such as limited space in innovation survey questionnaires prevent structured attempts to distinguish between the ultimate source of knowledge and the mechanism by which a firm gets access to it. For example, it is not possible at present to know to what extent knowledge from competitors is secured directly from them (e.g. through confidentiality agreements) or via mechanisms such as employee mobility, professional literature or participation in fora such as conferences. These mechanisms will impact on the interpretation of responses that cite “Competitors and other businesses from the same industry” as relevant sources of information. Since the proportion of companies that refer explicitly to collaboration arrangements with competitors is smaller than that citing this same group as a relevant source of information, there must be other mechanisms for companies to draw ideas and relevant knowledge from their competitors without the latter being actively and consciously involved.8 Potential examples include simple observation of the products they launch, reverse engineering, informal exchanges in trade associations and conferences, but potentially also information gathered from former employees.

16. From the perspective of companies that seek to protect their innovations, innovation surveys regularly point to the high importance of confidentiality agreements and secrecy. Unfortunately, the information is not detailed enough to shed any light on the extent to which these strategies involve the use of covenants restraining employee mobility. More so than for other forms of intellectual property rights protection, businesses responding to innovation surveys usually report trade secrets as very or somewhat important. Cohen, Nelson and Walsh (2000) asked a sample of manufacturing and research firms whether they had introduced a process and/or product innovation and which IP protection mechanism they considered effective. Patents were considered effective in 34% of product innovations and for 23% of process innovations, and were considered most effective in pharmaceuticals (50%) and medical equipment (55%). Secrecy scored 51% for product and 51% for process in all firms, with lead times 53% and 35% for product and process innovations, respectively. In Europe, Arundel (2001) used the 1993 CIS for innovative manufacturing firms in Norway, Germany, Luxembourg, the Netherlands, Belgium, Denmark, and Ireland to show that R&D performing firms give the highest rating to lead time, secrecy, complexity, patents and design registration in that order. Patents score 11.2% and 7.3% for product and process innovations (lead time 54.4% and 46.7%). More recent evidence for the United States from the NSF’s Business R&D and Innovation survey shows that more than 70% of software publishers, pharmaceutical and medicine manufacturing businesses and basic chemical manufacturing businesses reported trade secrets as important to their operations (Jankowski, 2012). Further, 98% of businesses in the semiconductor machinery industry reported trade secrets as important—no other industry reported a higher share of any type of IPR as important. Farooqui et al. (2011) estimate that approximately 52% of total investment in intangibles by firms in the market sector is not protected by formal property rights and that approximately 62% of the stock of knowledge assets in the UK market sector was protected by IPRs, an amount which mainly corresponds to estimates of investment in organisational capital and human capital embedded in workers (training).

17. Recent cross-country macroeconomic estimates of the size of business investment in intangible assets confirm the significance of knowledge-based assets, in particular economic competences which are embodied in employees. As shown in Figure 2 below, estimates following the methodology developed by Corrado et al. (2006) indicate that on average, one third of intangible investments (including R&D, design, marketing and software investment) appear to be accounted for by internal and external expenditures on training and organizational capital. Recent analysis by Squicciarini and Le Mouel (2012) suggests that the organisational capital estimates could be underestimated because of under-reporting of organisational capital-creating activities by individuals involved in non-managerial occupations who undertake related

outward knowledge transfer through the departure of employees, compared with 29% for patents and licences.

8 . The form of words typically used in the questions also leaves outside of cooperation routine contractual arrangements.


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organizational tasks. Only by maintaining a continued employment relationship with employees can firms secure exclusive access to and use of the organisation’s human capital and the assets embodied in its staff. Employees bring their previous education and talent to their job, own these skills, and are free to decide if and when and where they will contribute this capital to the firm. However, the human capital embodied in employees contains a great deal more than what the employee brought from previous experience, and includes newly acquired knowledge through training or qualifications sponsored by the employer that may be applicable, to a greater or lesser extent, in other companies in the same or different sectors.

Figure 2. Estimates of investment in training and organisational capital

As a percentage of total investment in intangibles

Source: OECD, based on INTAN Invest data. See Corrado, Carol, Jonathan Haskel, Cecilia Jona-Lasinio and Massimiliano Iommi (2012). "Intangible Capital and Growth in Advanced Economies: Measurement Methods and Comparative Results" available at www.INTAN-Invest.net

What do we know about skilled employees’ mobility?

18. Before discussing in detail the role of NCAs, it is worth discussing some of the literature of employee mobility amongst the highly skilled. Skills are essential for the development and diffusion of knowledge and constitute the crucial link between technological progress and economic growth, social development and environmental well-being (OECD/Eurostat 1995). Despite intermittent efforts in the 1980s, the methodology, collection and analysis of quantitative information on human resources devoted to S&T (HRST) has only recently led the analysis of staff devoted to activities other than just R&D. The study of the mobility of human resources for innovation is still in its early stage of development. The basic reason for this is not lack of recognition of the importance of human resource mobility, but the lack of systematically collected and comparable data. Few countries have established and systematically maintained data systems for the monitoring of stocks and flows of scientific, technical and engineering personnel deemed necessary for longer-term analysis or the examination of a wider range of issues. Since the mid-1990s, data enabling the study of HR mobility have become increasingly available following marked improvements in labour market databases, prompted by data linking, matched employer-employee databases and the enhanced use of administrative databases. With the domain of science, research and innovation statistics, a new wave of research studies has been making use of databases that enable the

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tracing of some aspects of individual careers. Thus, patent data information on inventors can now be longitudinally linked to assess instances of employer or geographic mobility by repeating inventors9, while similar inferences can be made about individuals with multiple scholarly publications (Elsevier, 2011). As new social media and networking tools become more comprehensive, such sources may also in future become potential mechanisms for tracing employee mobility.10

19. There are significant differences in general job mobility rates and average tenure across OECD countries, as displayed in Figure 3 below. With few exceptions, job mobility is by and large lower in most European countries compared to non-EU OECD countries, reflecting differences in labour market regulations but also general institutions and practices.

Figure 3. Employee turnover and tenure Job turnover in previous year as a percentage of total employees (left), and average tenure (right) in years

Source: OECD. Database on employment by job tenure intervals – persons. Data extracted on 5 August 2012 from OECD.Stat. Note: 2010 or most recent year (2009 for Australia, Mexico and Turkey).Data on tenure not available for non EU countries.

20. Within Europe, it is possible to use comparable microdata from the EU Labour Force Surveys (EU-LFS) to obtain more detailed estimates of job mobility patterns as well as recent trends and changes. The EU-LFS makes it possible to identify whether an individual has changed employer within the past 12 months. Figure 4 below shows that most European countries experienced increases in job mobility rates during the 2003-2007 period. This may reflect an increasing employee ability and willingness to change

9 . While tracing mobility through existing documents like patents or scientific literature help reduce the costs

and burdens of carrying out surveys, the principal downside of a publication-based approach is that the analysis of mobility to individuals is constrained to those who generate two or more relevant documents within the reference period. Furthermore, this approach requires careful disambiguation of inventor/author names so that mobility episodes are neither over- or under-reported. In order to reconstruct work histories, matching algorithms both for inventor and assignee names based on existing or new algorithms can be used to determine which patents were submitted by a particular individual.

10 . For example, the US Panel on Developing Science, Technology, and Innovation Indicators for the Future has noted the potential for developing approaches based on data on individual careers from sources such as Facebook and Google+ (generic networking sites); Mendeley (scientific networks) and LinkedIn or Monster.com (professional networking sites) for the purposes of constructing indicators of human resources for S&T and tracing their mobility.

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jobs throughout a period of economic growth. In contrast, mobility appears to have declined with the onset of the economic downturn in 2008, potentially revealing a reduction in the number of vacancies in addition to a reduced willingness to move jobs in unstable times.

Figure 4. Average annual changes in job mobility, EU countries As a percentage of employees and annual average change, with respect to previous year

Source: OECD, based on especially micro-aggregated data from EU Labour Force Surveys.

21. Using the same database, it is also possible to investigate differences in job mobility rates by sector of activity. Looking at the pre-downturn period (1997-2007), Figure 5 shows that employees in the computer services sector exhibit the highest mobility rates.11 Employees in professional services appear to be highly mobile but less so those in the R&D sector, who are in line with the median across different sectors. High mobility rates are also observed in sectors characterized by seasonal and less skilled employment, such as hotels and restaurants, construction, wholesale and retail trade. Within manufacturing, outside the recycling sector, the largest mobility rates are observed in the manufacturing of office machinery and computers and the manufacturing of radio, television and communication equipment.

22. In a comprehensive study of 2 800 Italian firms over the period 1985 – 1991, Pacelli et al. (1998) found that workers in innovative industries have a much lower probability of separation– i.e. quits plus layoffs from the firm of employment – than workers in traditional industries, after controlling for other firm and worker characteristics. However, job-to-job moves – which account for a subset of all separations, defined as quits not interrupted by unemployment spells – are much more frequent in more innovative sectors than in more traditional ones, as well as more common among non-manual workers than among non-manual ones.

11 . Within the computer services sector, mobility rates range from close to 23% for Ireland to 5% in Greece.

Iceland, Turkey, Estonia, the Netherlands, United Kingdom exhibit the highest mobility rates with values close to 20%.

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Figure 5. Job mobility, by sector of current employment, 1997-2007 As a percentage of employees by sectors (NACE Rev1.3, 2-digit sectors), median across EU countries

Source: OECD, based on especially micro-aggregated data from European Labour Force Surveys. Eurostat.

23. Observed differences across sectors may suggest some relationship between skill level and mobility. The reality, as Figure 6 below suggests, is a somewhat more complex, as mobility for the skilled is not necessarily higher across all countries. Skilled workers in Ireland, Sweden, the Netherlands and Slovenia are on average 20 % more mobile than their unskilled counterparts, while in Spain, Czech Republic, Turkey and Hungary mobility is largest amongst the workforce without tertiary education qualifications or professional occupations.

Figure 6. The relative mobility of skilled employees in EU countries Ratio of mobility rates (tertiary educated or professionals vs rest of workforce)

Source: OECD, based on especially micro-aggregated data from European Labour Force Surveys. Eurostat.

24. The empirical relationship between employee mobility and innovation is a highly complex one, and the evidence is mixed. The scope for mobility and the existence of potential barriers come into play in defining incentives for incumbent firms, their employees and other firms to invest in innovation and related activities and set up new ventures. A number of studies have attempted to look at the direct impact of mobility and productivity by comparing countries, typically finding a positive relationship between tenure and labour productivity (see for example Auer et al 2004).

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25. Probably the least well-understood of all these relationships concerns the role of employee mobility in driving knowledge flows and their net impact on innovation. The evidence on inter-firm knowledge flows mediated through employee mobility does not appear to be as comprehensive as its alleged importance might otherwise suggest. This may be due to limited data sources on employee mobility that can be suitably linked to measures of firms’ innovation activity and overall performance. One notable exception is the study by Maliranta et al. (2009), who use matched employer-employee data for Finland to look at the impact of mobility episodes of personnel working in R&D labs. They find strong evidence of firm‐to‐firm knowledge spillovers but not of the most obvious type, as hiring workers from other R&D labs to one’s own does not seem to be a statistically significant spillover channel. Instead, hiring workers previously engaged in R&D to one’s non‐R&D activities is observed to boost both productivity and profitability. This is interpreted as evidence that these workers transmit knowledge that can be readily copied and implemented without much additional R&D effort. The authors also suggest that knowledge spillovers associated with R&D and channeled through inter‐firm labor mobility may be partly, but are not fully, internalised by the labor market. Thus, inter‐firm labor mobility is indeed found to be a channel of knowledge spillovers.

26. Walsh and Nagaoka (2009) use a survey of US and Japan-based inventors named in triadic patents (patents filed in Japan and the EPO and granted by the USPTO). They find that American inventors are much more mobile (although Japanese inventors with PhDs also have high rates of mobility, mainly in the form of secondments). A number of factors, amongst which cultural and financial incentives may add to the role of NCA legal enforceability, could help explain the finding that Japanese firms are more likely to get inventors who move vertically (from customers or suppliers), while US inventors are more likely to move horizontally, across competitors or others in the same industry. For example, in the US, 45% of moves to large firms were from competitors (8%) or others (31%) in the same industry, while in Japan, 16% of moves to large firms are horizontal (4 and 12% respectively). In contrast, in the US, for large firms and SMEs, about 6% of moves are vertical, while in Japan, about 20% are vertical. They also find that, in both countries, mobile inventors generally make greater use of external information sources, especially information from universities and from competitors (although only for secondments in Japan).

27. There are many studies which point to job mobility as a key driver of cluster development and localized knowledge spillovers. For example, an abundant local supply of skilled and specialized labour can be one key pre-condition for local economic specialisation and dynamism. Furthermore, the ability to move to other firms as their relative fortunes vary without undergoing the disruptions associated with major geographic mobility can be an important factor in driving individual career decisions to specialise in nascent technological domains. In the absence of options to be mobile while preserving their skills, individuals may be enticed to take on safer career paths and invest in more generic types of knowledge. Furthermore, the mobility of skilled workers is also deemed to represent a crucial source of new firm formation as well as the main mechanism through which technical and market knowledge flows locally (Breschi and Lissoni, 2001). This type of mobility is not necessarily associated with technological spillovers as traditionally understood, as the knowledge flows are mediated by market mechanisms amongst which the labour market plays a leading role. Breschi and Lissoni (2001) develop further this argument by noting that evidence of localised spillovers may be purely explained by the role of face-to-face contacts in facilitating access to information about who knows what and where it is employed, which they describe as the sole public good –i.e. the only source of external, non pecuniary effects– rather than just information being transmitted locally through employee contact.

28. A well known example in this literature is the study by Almeida and Kogut (1999). They examined the mobility patterns of individual holders of semiconductor-related highly cited patents in a number of industry clusters, finding high levels of mobility strongly localised, but only in Silicon Valley where mobility was also found to affect positively the innovation rate of local firms. Tambe and Hitt (2007, 2011) used inter-firm mobility data to test whether employee mobility results in significant


16

spillovers of IT-related process innovations. Instead of using inventor data from patent records, in order to characterize a firm’s labour network position, they use data derived from the employment histories (“resumés”) of over ten million US workers (8-10% of the entire US workforce).12 Their estimates suggested that worker mobility was an important channel for the diffusion of IT-related process knowledge.13

29. Masso et al. (2012) also use CV-based data from a leading job search portal in Estonia (CV-Keskus) and match circa 261 000 employment histories of job searchers, matching the employer names with the database of the Estonian business register on all of the business enterprises. The mobility data was thereafter merged with data from the Estonian Community Innovation Survey. The authors show that product innovations and total factor productivity are associated with subsequent higher worker flows from other, especially innovative, firms. Among flows involving people in different occupations, the flows of managers and professionals and technicians appear to be more important.

30. Some researchers have also challenged the prevailing conception of mobility as an event that creates a unidirectional flow of information from the previous employer to the new employer and highlighted the social and repeated interaction dimension of mobility and related tacit agreements (Rogers and Larsen, 1984 and Von Hippel, 1987). Agrawal et al. (2006) have provided evidence on how knowledge spillovers across regions are promoted by enduring social relationships between individuals, while the study by Corredoira and Rosenkopf (2009) focuses on the transfer of knowledge as measured via patents and citations by the former employer to the departed employee, in contrast with studies that focus on the on the transfer of capabilities and may rely heavily on the transfer of clients. The authors implicitly argue that business-competency like assets, such as client relationships, are more susceptible to move to new employer and be severed at the previous employer.

Restrictions to mobility and potential implications

31. Despite the potential benefits accruing both ways, employee departure episodes destroy match-specific value created through investment by both employers and employees, yet the possibility of offering one’s labour to a higher paying firm is one of the few mechanisms available to ensure vital competition in the market for labour so that employees can be rewarded for the services provided in line with their contribution to the company performance. Marx and Flemming (2011/2) have drawn attention to the implications of restrictions to the mobility of skilled labour for entrepreneurship. The implementation of a new venture requires the flexible and agile recourse to financial and human resources. While this may be seen as a zero sum game if employees leave their organisations to join new ones, “job hopping” facilitates the rapid reallocation of human resources towards firms with the most promising innovations. There are a number of reasons why efficient arrangements to deal with the costs and benefits of employee mobility are particularly difficult to guarantee in the real world:

• Considerable asymmetries (informational and market power-related) characterise the interactions between incumbent employer, employee and potential new employer in a “job hopping” episode. Recruiting companies typically have less information about the quality of potential new employees, conferring a significant advantage to the incumbent employer. Employees can also have limited information about opportunities elsewhere, and their mobility may be bound by a wide range of factors (e.g. sunk investments in home property, family ties, etc…).

12 . An important advantage of this data source over existing worker flow data is that in addition to

employment history information, it includes occupational categories, job titles, and human capital variables for each worker.

13 . Lundmark and Power (2007) argue labour market mobility is significantly higher in growing clusters than in the rest of the urban economy based on evidence from the Stockholm ICT cluster.


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• Another substantial asymmetry stems from the loss of an employee for the source company, which not only has to write off a substantial part of the human capital investments vested on the employee, but also faces the possibility that the knowledge taken away might eventually benefit a direct or potential competitor. Employment contracts are solely between employer and employee and can therefore not bind other firms which do not internalise the impacts of attracting an employee away from its previous employer, which in turn will depress incentives by employers to invest in their employees’ transferable skills.

• Contracting at the outset of the employment relationship on all circumstances that may arise throughout the course of the employment relationship and afterwards is an impossible task. This leads employers and employees to negotiate and eventually agree on a basic yet blunt set of rules which define not only the rights and obligations of each party during the employment relationship but also set out some restrictions that apply should the relationship terminate. Less experienced parties are more likely to agree (or even be coerced to agree) to terms which are not necessarily in their own interest.

• In particular, it is difficult to verify and prove to third parties to what extent employees may have misappropriated knowledge from their previous employers and use it in their next job, either as entrepreneurs or employees for another organisation. Litigation can be expensive and favour less credit constrained parties.

• Incumbents and larger firms tend to be less-credit constrained than start-ups and may find it as a result much easier to entice critical employees to quit their jobs in companies developing competing products which challenge their company’s dominant position.

32. Over recent years, markets have been witnessing a number of developments which have contributed to altering the complex interactions between these asymmetries and the arrangements and institutions used by companies, employees and public authorities to address them. For instance, ICT developments have made it easier to copy and transfer information independently of distance. ICT-based tools have also enabled employees to build virtual networks, raise their individual profiles online and look for a better employer match, while former employers can also more easily identify what their former employees are up to. Competition in product and labour markets has become increasingly globalised; a restraint to operate in a neighbouring area can be rather meaningless when a distant competitor competes with the firm in a specialised, global market while the rapid pace of product development in many sectors implies that a restriction to work in a given subject for a given amount of time becomes more damaging for the employee whose skills would depreciate faster. Companies now appear to find it more difficult to commit to rewarding tenure and employee loyalty, given the challenges faced by company pension funds, stock market volatility and potential opportunities for out-sourcing and off-shoring jobs, also aided by a trend towards deregulation and less onerous employment protection legislation.

33. In sum, the loss of experienced workers to actual or potential competitors can be considered as one of the “destructive” dimensions of the Schumpeterian process of creative destruction. High rates of job mobility which can be associated with deregulated flexible labour markets may prejudice the diverse know-how and practical problem solving skills embodied in individual experts if they are not retained by the firm. Highly innovative firms have a problem of reproducing what has been learnt into an organizational memory and so are highly vulnerable to individuals leaving the organization (Lam and Lundvall, 2007). As a result, firms develop strategies aimed at asserting proprietary control over technologies, know-how, and other forms of knowledge-based capital through explicit or implicit agreements with other companies and their employees. Non-compete agreements are probably the most salient example of those restrictions. The next section will look at how widespread they are and examine to what extent regulators and the courts are willing to promote and enforce such agreements.


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3. The use and legal enforcement of non-compete agreements in employment contracts

The use of non compete agreements

34. Non-compete agreements have been described as amongst the most sophisticated contractual instruments used in employment law today (Ius laboris, 2011). By agreeing to non-compete clauses, either within the employment contract or separately14, the employee pledges not to carry out a set of pre-defined activities for competing firms if a number of conditions are met. Such conditions typically entail activities that are prescribed (e.g. an outright ban on working for a competitor), starting up her own business, field of services, and geographic and time limitations after the termination of the employment relationship with the current employer. NCAs can also include specific provisions regarding protection of confidential information, former client and colleague solicitation, etc… and some cases, the NCA may include additional provisions which oblige the employer to compensate the employee for such restrictions (e.g. by granting gardening leave or paying a fraction of her average salary). NCAs could also set out potential compensation levels for infringement by either party (including potential forfeiture of stock options and other benefits) as well as payable sums by either party to rescind the agreement. The NCA, alongside the entire employment contract, may also include provisions that dictate the choice of legal forum under which the agreement is to be enforced, a feature which is particularly important in an increasingly global work environment.

35. As with most private agreements, there are no systematic and official data registers from which it is possible to infer what proportion of employment contracts contain non-compete clauses. A cursory examination of internet searches using Google Insights for the term “non compete” reveals “non compete agreement” as the most searched amongst all related items. Even discounting the language bias, the United States appears to be the main source of searches as the relative incidence of searchers exceeds that of other English speaking countries. Furthermore, a query of the term ‘NCA’ translated into other languages showed more modest results for other countries. Within the United States, the highest search intensity appears to be found in the state of Florida, which is deemed by a number of studies to be the one with the strongest level of legal enforcement for non compete agreements (Bishara 2011). As a matter of fact, searches for “non compete agreements” are closely linked to searches for model templates “sample non complete” (#1) and “non compete template” suggesting real practitioner and potentially employee interest, and related terms such as “non disclosure” (#3) and “non disclosure agreement” (#4). Most geographical references to co-searched items do indeed refer to Florida and Texas15. This also applies to other variations identified by Google Insight as co-searched, such as “noncompete”, “non compete clauses”. Search trends are summarised in Figure 7 below. Over the 2006-2012 period there are no dramatic increases in search intensity but it is significant to note that with an expanding array of possible searchers, this topic manages to retain a considerable interest. The term confidentiality agreement is found to be the fastest growing co-searched term.

14 . It is rare but not uncommon that non compete agreements are presented to employees after the employment

relationship has started. In Canada, an employee challenged his dismissal from a pharmaceutical company. He had been dismissed based on his refusal to sign a non-compete agreement that had been discussed in his initial offer letter, but which was not presented to him until three years into the employment relationship. The Québec Court of Appeal [2012 QCCA 232] unanimously ruled that the employee’s refusal to sign the non-compete agreement proposed by the company did not constitute just and sufficient cause for his dismissal.

15. A recent Texas Supreme Court opinion changed Texas noncompete law making it easier it easier for an employer to enforce a noncompete agreement. Marsh USA Inc. v. Cook, No. 09-0558 (Tex. June 24, 2011), available at http://www.supreme.courts.state.tx.us/historical/2011/jun/090558.htm.


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Figure 7. Search trends for non compete agreements, 2006-2012

United States, Google Insights normalised measure of relative web search interest

Source: OECD, extracted from “Google Insights”, August 2012. Note: Web search interest figures do not represent absolute search values and trends, but relative to total (increasing) searches in reference country. 8-week moving averages reported.

36. In addition to evidence of an increasing practical interest as revealed by the intensity of related searches, legal information on litigation cases related to NCAs can be used to identify to what extent employers request courts to enforce the agreements. As with any litigation data, this will only provide a partial picture of the actual impact of NCAs as these are likely to have a deterrence effect on mobility episodes that give rise to employers requesting the enforcement by courts. The available data, depicted in Figure 8 below, suggest that the number of court cases related only to “non compete agreements” slows down in parallel with the economic downturn, revealing the reduced scope and incentives for job-to-job mobility amongst the broad economy.16 However, the number of cases involving both NCAs and trade secrets continues to experience a sustained increase. There are a number of potential explanations for this distinctive pattern. For example, new employers may be seeking to recruit their competitors’ key staff to gain a competitive edge amidst a more difficult background. There may also be sector-specific factors at stake, and trends could be driven by sectors that have been experiencing rapid growth.17 Former employers may also be attempting to improve their litigation outcomes by demonstrating an additional loss of trade

16 . This type of data has also been used by Png (2012), who searched the Lexis-Nexis legal database for all

federal and state cases from 1960 onward including “covenant not to compete" in the headnote.

17 . There have been some high profile managerial moves within the ICT industry, in which companies have recruited leading executives from competitors. In 2005, the year in which an acceleration in the number of NCA and trade secret cases is observed, Microsoft and Google litigated the enforceability of a non-compete clause of a former Microsoft employee that went on to work for Google. Also in 2005, in return for $11.5 million, Motorola dropped its attempt to prevent a former executive from becoming the CEO at rival Nortel Networks. The settlement also put restrictions on the executive’s dealings with Motorola-related matters. In 2008, Mark Papermaster, IBM's Vice President of the Blade Development Unit, became the subject of a notable trade secret misappropriation and non-compete clause case when he announced a plan to move to Apple as Senior Vice President of Devices Hardware Engineering. A settlement was reached in 2009.

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secrets. When the District Court adopted “inevitable disclosure” doctrine in 2000 – whereby employees who are given access to trade secrets may be prevented from working for competitors if the new job would "inevitably" require the employees to use or disclose their former employer’s trade secrets - this was seen as a valuable new tool for employers who needed to protect their confidential information and trade secrets. However, by de-publishing the appellate court decision, the Supreme Court tacitly rejected the doctrine and limited employers’ ability to prohibit key employees from competing.18

Figure 8. Litigation trends for non compete agreements

United States, total numbers

Source: Beck (2012), based on LexisNexis information on litigation cases. Accessed from http://faircompetitionlaw.com/

37. A number of legal sources point to NCAs being a common feature of employment contracts, particularly among professionals and managers. There is no shortage of legal guidance offered online advising firms on how to draft tight NCAs, how to use related covenants and agreements to help protect business interest when these are not enforceable and advising on which jurisdictions treat NCAs more favourably in order to adopt those as the relevant choice for applicable law.

38. There have been a number of very recent cases where the use of and litigation around NCAs has been brought to the public attention. A severance accord in summer 2012 between General Electric and a retiring executive in charge of energy infrastructure prevents the latter from competing with the company for three years, about three times as long as what’s typical in such cases in what was deemed to reflect the valuable knowledge held by GE’s departing executive.19

18 . Electro Optical Industries, Inc. v White (1999) 76 CA4th 653. See also http://www.pandab.org/inevitable-

disclosure.html

19 . http://www.bloomberg.com/news/2012-08-03/ge-pays-12-9-million-as-energy-chief-kept-from-rivals.html When Google executive Marissa Mayer gave notice in July 2011 and started working as the CEO at Yahoo, one of the queries making the rounds on Mayer’s Google Plus circles and various Twitter accounts referred to whether she had a non-compete.

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39. Turning to detailed evidence on the use of NCAs, a few studies provide information at the level of individual employees and companies. Kaplan and Stromberg (2003) note that venture capital contracts routinely stipulate that their portfolio companies must have non-compete agreements with employees. Garmaise (2011) reviewed the incidence of NCAs among top executives within a random sample of 10K forms corresponding to 500 publicly-held companies from Standard and Poor's Execucomp database. For 70% he found evidence of non-competition agreements between the firm and its top executives and he established a relationship between the degree of enforcement in the state where the firm’s headquarters is located and the existence of an NCA. A one-standard deviation increase in the enforceability index from its mean raises the probability of disclosed use of non-competition agreements from 70 to 75%. Schwab and Randall (2006) analysed executive noncompetes from the same source and found 67% of employment contracts contained some non-competition clause which could in many cases be triggered by any type of employment termination, independently of the reason for the separation.

40. Marx (2011) appears to be the first to look at the incidence of NCAs outside the population of executives. He conducted 52 in-depth interviews with patent holders in the automatic speech recognition software industry corresponding to 110 combinations of individuals and job moves (i.e. dyads). He found that for 38% percent of individual-company pairings the inventor had been asked to sign a non-compete agreement. He also carried out a cross-industry survey of IEEE20 members. Of 276 respondents who signed non-competes and changed jobs, nearly one third reported taking a job in another industry. He also found some evidence of the strategic use of NCAs by employers, as implied by the fact that 70% of non-compete requests were handed out for signing by the employee only after the job offer has been accepted, mainly on the first (or even after) the first day at the company. This calls into question a simple interpretation of NCAs as intended to protect proprietary information, unless employers believe it is not in their interest to put off prospective employee who may be entertaining the thought of taking away trade secrets and other confidential information. In this context, the coercive imposition of NCAs following acceptance of a job offer can only be understood as improving the forward bargaining position of the employers by increasing the exit costs to the employee.

The enforcement of non-compete agreements

41. The effectiveness of non-compete agreements entered into between employees and their employers clearly depends on the extent to which authorities are willing to enforce them. Before entering a discussion on what might be the pros and cons of such enforcement, the purpose of this section is to describe the extent to which countries and regions within them differ in terms of how NCAs can or cannot be legally enforced. Assessing the enforceability of non-compete agreements requires paying attention to a multi-dimensional and complex range of features partially captured by statutes and case-law.

42. By and large, authorities are typically willing to enforce constraints in employment contracts as long as these can be considered to be “reasonable”. By default, there is a public interest in maintaining competition and the freedom of the employee to move freely within the workforce, particularly the effect of the restraint upon the future employment prospects of the employee after termination of the employment. There is also a primary interest in preserving as much as possible what willing parties have voluntarily agreed to, although in the context of employment law this is usually given less importance than in the context of, say, agreements which are incidental to the sale of a business. Beyond these basic and sometimes opposing principles, the fundamental driver of “reasonableness” is that there must be a legitimate proprietary interest of the employer to be protected that requires the use of a NCA. This is where statutes and case law come to very different interpretations, given the several dimensions at stake. In particular, enforcement decisions will need to consider whether temporal and geographic restraints are too broadly or narrowly defined. 20. The Institute of Electrical and Electronics engineers, a US non-profit professional organisation.


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United States

43. While there are legal sources describing enforcement practices worldwide, the description, codification and empirical analysis of legal regimes for NCA enforcement has only transcended the pure legal domain in the case of the United States, where academic and general interest in this topic is notable. A key feature of the US relates to the variability in practices across different states, as there is no uniform federal legislation governing covenants within employment contracts across the entire territory. While there is a plethora of different information sources, Malsberger (various years) is the most cited because of its comprehensiveness and regular updates, reflecting recent court decisions. Garmaise (2011) built an index of NCA-related case law based on a periodic survey of substantive state NCA law by the American Bar Association, Section of Labor and Employment Law. Using the fourth edition of the Malsberger survey, Garmaise (2011) compiled a zero-one score for each of twelve dimensions of the enforcement of CNC law in the states, and added the twelve items to create an overall score. Garmaise's (2011) index covered the period 1992-2004 and varied over time in only three states (Florida, Louisiana, and Texas).

44. Bishara (2011) called into question the dichotomous approach to classifying jurisdictions on the basis of their NCA enforcement, describing it as overly simplistic and missing the subtleties of NCA enforcement rules. A legal scholar himself, he proposed a structured approach towards scoring diverse relevant features of the full variety of statutory and case low, based on the questions applied in the Covenants not to Compete treatise. These questions relate to (i) the existence of a state statue governing the enforceability of NCAs; (ii) the definition of the employer’s protectable interest; (iii) what the plaintiff must be able to show to prove the existence of an enforceable NCA; (iv) whether the signing at the inception is sufficient consideration to support the NCA; (v) whether changes in terms and conditions provide sufficient consideration after the start of employment and whether continued employment does so; (vi) whether the courts are permitted to modify (i.e. moderate but still render valid) the covenant to make it enforceable; and (vii) whether the covenant is enforceable if the employer terminates the relationship. Each of these questions is essentially given a high, medium or low score (10, 5 or 0) depending on how much these features facilitates the enforcement of NCAs and a weighted sum is compiled resulting in an overall score. The ranks associated with the scores assigned in 1991 and 2009 are reproduced in Figure 9 below.

45. Bishara’s results show nine states (two of which ban NCAs, i.e. California and North Dakota) that are “weak enforcing states”. Twelve states strongly enforce NCAs, led by Florida. The remaining thirty middle ranked states are described as “moderately enforcing jurisdictions. Georgia and Texas experienced the largest reduction in strictness over the period, while Louisiana saw a near opposite change towards more enforcement, followed by Idaho. These changes represent the impact of both changes to state-level status as well as court decisions, each reflecting to some extent of local debate and positions on the issue. The period covered by Bashira’s assessment excludes the 1985 apparently inadvertent repeal of an 80-year-old statute as part of the Michigan Antitrust Reform Act (MARA), which included a prohibition on the enforcement of non-compete agreements. As will be discussed in a subsequent section, this change has been used in the literature as a “natural experiment” as part of efforts to investigate the impact of NCA enforcement.


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Figure 9. The enforcement of NCAs across US states, 1991-2009 Rankings (1: Strictest enforcement-51: Weakest enforcement) and changes over the period

Source: Bishara (2011)

International evidence

46. This project set out to fill an evidence gap by documenting how countries differ in their enforcement of NCAs. A thorough literature search did not result in the identification of empirical studies which laid out the incidence of NCA agreements and enforcement outside the United States, although numerous legal sources were identified online describing national practices. An initial investigation of those sources revealed differences across countries as marked as those found across states within the United States. The information contained in reports by legal firms such as Ius Labouris (2010), Lex Mundi (2010), Meritas (2010), Fenwick (2011), Howse et al. (2012) lends itself to a similar type of analysis to that carried out by Bishara (2011). In addition to this, reports from a meeting of European Labour Court Judges hosted by International Labour Organisation (ILO, 2006) provided valuable additional information for a number of participating countries. The information contained in all these reports varies in terms of coverage, scope and depth but it does in many cases conform to the similar structure of key features that define the enforceability of NCAs in a given jurisdiction.21 To the best of our knowledge, no previous attempt has been made to codify the subtle differences in legal regimes concerning NCAs and summarise them as an index.

21 . In some small countries, some reports indicated lack of relevant statutes or decisions that could clarify the

country’s actual position. It was not possible to find comprehensive responses to all questions for all countries. An intermediate score was imputed in those cases.

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Mar

ylan

d H

awai

i Io

wa

Ver

mon

t Id

aho

Loui

sian

a

Ranking 1991 Change ranking: 1991-2009 Ranking 2009


24

Table 1. Codification of legal restrictions on NCA enforcement

High score Medium score Low scoreStatute and enforceability Is there a state statute of general application that governs the enforceability of covenants not to compete?

Statutes are in place that favour strong enforcement of NCAs

There is no statute or when there is, it is neutral in its stance towards NCAs

There are statutes that significantly disfavor or ban enforcement

Breadth of protectable interest What is an employer’s protectable interest and how is that defined? To what extent does it differ from trade secret and related protections?

The protectable interest is very broadly defined

Balanced approach to defining the protectable interest

The protectable interest is very narrowly defined

Time limitations Do statutes/courts enforce NCAs with terms longer than one year?

Typically they do accept such terms

Terms longer than one year sometimes allowed

Terms of more than one year generally precluded

Functional limitations Are certain occupations, workers or groups exempt from NCAs?

Enforced for all types of workers

Some occupations exempted, earnings thresholds

Applicable to very limited set of occupations and types of workers

Compensation Is compensation formally required to support NCA or a factor considered in assessing reasonableness?

Compensation is not required and not taken into account

Some compensation required

Not accepted or very generous compensation required

Burden of proof What must the employer be able to show to prove the existence / reasonableness of an enforceable covenant not to compete?

Weak burden of proof on employer – burden on employee to waive NCA

Balanced approach to the burden of proof

Very strict burden of proof on the employer

Formal requirement for consideration Is a written agreement required and does the signing at inception provide sufficient consideration to support the NCA?

Written agreement not required. Start of employment sufficient

Sometimes sufficient to support NCA.

Independent consideration needed

Changes in circumstances Are NCAs still enforceable if employment circumstances change?

Valid if circumstances change?

Beneficial changes sufficient to support NCA.

The NCA is void if circumstances change

Termination Does the reason for contract termination define the enforceability of NCAs?

Always enforceable if employer terminates

Sometimes enforceable

Never enforceable if employer terminates

Modification by courts Do courts have the power to modify NCAs to ensure their enforceability?

Judicial modification allows - limited restrictions on maximum enforcement

Blue pencil: modifications were allowed to reform the contract instead of disallowing it outright

NCA deemed void if it does not to meet full legal requirements

Remedies Do courts grant preliminary injunctions and/or damages?

Courts grant preliminary injunctions

Limited damages, no preliminary injunction

No injunctions – very limited / no damages

International Are foreign NCAs enforced in the territory? Always As long as consistent

with local rules Apply domestic rules not to enforce

Source: OECD, principally based on Bishara (2011).

47. The codification of country features is laid out in some detail in Table 1 above. In short, the questions applied by Bashira (2011) were also used in assessing national features, with a few additional questions which focused in particular on a number of aspects concerning functional (are there occupations/activities a priori exempt from NCAs) and time limitations to compete (taking the extent to


25

which NCAs can apply for more than one year as the key reference point) as well as the requirement on employers to compensate employees. The range of allowable remedies was also included as a few countries appear to constrain the use of damages and/or injunctions. Some aspects, not covered either in Bashira (2011) were not fully documented, such as the baseline position taken by the law when there is no NCA in place or whether new employers are potentially liable.22

48. It is important to note that the analysis is experimental and has not yet been subject to validation by legal experts. However, contrary to our initial presumption that it would probably be unfeasible to differentiate across countries, the application of principles varies significantly from country to country, and in some cases, within countries and population groups. Within a jurisdiction, judges will differ on the application of the reasonableness test. The results from the experimental exercise in scoring national systems along a number of relevant dimensions are displayed in Figure 10, showing the average scores against the country or regional overall ranking.

Figure 10. Legal restrictions to the enforcement of non-compete agreements Enforcement ranking and scores

Source: OECD, experimental scoring results and rankings based on a number of legal sources. The enforcement score and rank for the Slovak Republic is based on pre-2011 reform information.

49. The results include scores for three US states (California, Texas and Florida). California is joined by a number of countries in the group of jurisdictions which do not enforce NCAs to any significant degree, on top of the requirements from other agreements to protect trade secrets or other business interests. This group of countries includes the salient examples of India and Israel, which share with California the attribute of hosting highly dynamic ICT sectors and having attracted large volumes of VC

22 . Some countries appear to adopt a more extended interpretation of unfair competition rules.

0

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4

5

6

7

8

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10

15

20

25

30

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Enforcement ranking Enforcement score (right axis)


26

investment, in what might be considered as evidence supporting the view that such agreements restrict knowledge flows and innovation. However, there are also countries with very diverse innovation performances such as Mexico, Luxembourg and the Slovak Republic and the Russian Federation within this same group. Chile and a number of “common law” countries such as United Kingdom, Australia23, New Zealand have regimes in which the enforcement of NCAs is permitted but under rather restrictive circumstances. Most European continental countries have regimes which enable a more permissive approach towards NCAs, although their statutes often require the payment of compensation to employee that is subject to such a covenant. It is not straightforward to assess whether it is reasonable to rank as being most permissive countries those which do not require any form of compensation but take a strict view regarding what is a protectable interest (the predominant common law approach), and those which adopt the opposite approach. This results in relative small scoring differences across many countries, which causes the ranking to be rather sensitive to the weights placed on the various dimensions.. Some illustrative examples are provided in Tables 2 and 3 below.

50. An important feature of the scoring profile is that as enforcement scores increase, the differences between countries in successive ranks become increasingly small. Only a few countries prevent the use of NCAs, with scores raising for those countries with light enforcement rules, for them to be rather minimal scoring differences for the majority of countries. The actual ranking of countries is thus very sensitive to the use of weights or to the potential omission of relevant case court evidence in the original scoring. Another potential constraint in the use of the indicator is the lack of longitudinal information which can provide a basis for quasi-natural experiments. Only a limited number of regulatory or case law changes over time could be identified from the available information, making it very difficult with current sources to construct a database that codifies and track changes over time in the enforceability of NCAs across different countries. Specific examples include:

• In France, a Supreme Court ruling in July 2002 required that all noncompete clauses provide for the payment of financial compensation as a condition of the validity of the clause.

• In Israel, the 2006 National Labour Court decision in “Dan Frumer and Checkpoint Software Technologies v. Radguard”24 overturned a decision to enforce an NCA by judging there was little risk of the employee using Radguard’s trade secrets in conjunction with his new employment. In the AES System v SAAR case, the Supreme Court invalidated the clause preventing a former employee from offering competitive services in connection with software supplied by the former employer, who also offered such services, claiming that the clause harmed the former employee’s right to freedom of occupation and stating that the employee did not use the former employer’s trade secrets with regard to the single large customer that transferred its business from the former employer to the former employee.

23 . Restraints can be drawn more liberally in New South Wales where legislation enables the Supreme Court

to "blue pencil" amendments.

24 . A few months after ending his employment at Radguard, Dan Frumer began employment at CheckPoint Technologies as a Research Manager/Coordinator. His new position required similar responsibilities as at Radguard, but not in exactly the same field. Radguard felt that its proprietary information and trade secrets were at risk because of Frumer’s new employment and filed for injunctive relief barring Frumer’s employment with CheckPoint for a period of 18 months. On appeal, the National Labor Court reversed the District Labor Court which had previously found the non-compete provision binding on Frumer and granted Radguard’s request for injunctive relief. The Court ultimately held that in this particular situation there was little risk of the employee using Radguard’s trade secrets in conjunction with his new employment. As such, the noncompete provision was deemed unreasonable and not enforceable. Available at: http://www.constitution.org.il/index.php?option=com_consti_comp&mytask=view&class=1&id=973


27

Table 2. Country observations and comments – NCAs not or lightly enforced

Country

General comments and key features

Mexico Under Mexico’s Constitution (Article 5), nobody can be impeded from dedicating to the profession, industry, business activity or type of work that she/he so elects. In the context of an employment agreement, provisions can only deviate from labour law principles if such deviation is more favourable to the employee and the employee’s Constitutional guarantees are not violated. An employer may not specifically enforce a covenant not to compete, but any breach of such covenant may give rise to an action of money damages.

Russian Federation

Russian law does not allow for an employee to be restricted from working for another employer (a competitor of the company) during the employment or for some time after its termination. If a non-compete clause is included in an employment contract, it cannot be legally applied and will not be enforceable in the Russian courts. In practice, many employers (especially companies with foreign management) often include non-compete provisions in their employment contracts and other labour related documents as a ‘moral’ obligation on the employee. The provisions of Russian law on the protection of information comprising commercial secrets (including production secrets) of the company are reported to be in turn rather strict.

United States (California)

Under California law, covenants not to compete are generally void and unenforceable: “Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void.” Cal. Bus. & Prof. Code § 16000.

Israel Recent case law (see main text) has led some authors to conclude that Israel’s National Labor Court’s interpretation of the Basic Law of Freedom of Occupation effectively coincides with the California approach to NCAs. (Royker, 2011)

India Agreements in ‘restraint of trade’ are governed by Section 27 of the Indian Contract Act 1872. Generally speaking, the validity and enforceability of a non-compete clause usually depends on whether or not such a clause constitutes or amounts to ‘restraint of trade’, which apart from a few exceptions, is barred by law. All restrictions which operate after the term of the contract are void except in cases of the sale of goodwill, where protection may be given to the buyer. An employer would only be entitled to protect his proprietary interest, namely his trade secrets, confidential information, intellectual property, etc. and can in no way restrict an employee from working with anyone after termination of the contract.

Slovak Republic (Up to September 2011)

Non-compete clauses which apply after termination of employment were not permitted under Slovak law prior to 2011. Work Inspectorates were able to impose a fine of up to EUR 100K if the employer had concluded a non-compete clause with its employee. However, from September 2011, an amendment to the Act 311/2001 Coll. Labour Code introduces the possibility of using NCAs that apply after the conclusion of the employment relationship.

Czech Republic The employer is obliged to compensate its employee with his or her full average salary during the effective period of non-competition. The maximum period is 12 months.

Luxembourg it is not possible to prevent an employee from working in competition with the former employer if this is done through a new employer, as the Luxembourg labour code only serves to prevent former employees from running their own businesses and does not stop employees from working for competitors within the framework of new employment contracts. Annual gross salary of the employee concerned must be at least EUR 47,875.60. It cannot be extended outside the Grand-Duchy of Luxembourg. A non-compete clause must also to be restricted to a specific professional sector as well as to professional activities which are similar to those performed by the employer, limited to a maximum 12 month period.

United Kingdom Covenants not to compete after the end of the employment are unenforceable unless the employer can show that they are reasonable. Courts favourable to preventing restraints on trade. Less than one year in practice. Trade secrets and confidential information are automatically protected even without a covenant.

Chile Non-compete clauses made after termination of the employment contract are only accepted to a limited extent as they are deemed to be in conflict with the constitutional rights established in Article 19 Nos 16 and 21 of the Constitution, namely freedom to contract in labour matters and the right to develop any economic activity. The “Dirección del Trabajo” has rejected non-compete clauses having effect after termination of the employment contract by Ruling 4,392/187 dated 6 August 1992 and Ruling 5,620/300 dated 22 September 1997.

Australia Common law declares restraint of trade clauses as prima facie void as considered against public policy. Restraint clauses must be proved reasonable. No formal requirement on compensation. New south Wales allows contracts to be modified.

Source: OECD, based on multiple sources.


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Table 3. Selected examples of countries with NCAs medium or strongly-enforced

Country

General comments and key features

Germany The material requirements for the validity and enforceability of an NCA are also set out in Sections 74 to 75d of the German Commercial Code. The constitutional court decided in 1990 that the freedom of occupation could not be completely ignored by the parties of a contract, when they sign the contract. Agreement must be in writing, provide for compensation. Time limit maximum of 2 years, broad interpretation of business interest. Compensation must be at least half of most recent remuneration. Broad definition of business interest.

France Based on case law and collective agreements. Without financial compensation the NCA is null and void. Broad definition of business interest. Courts can modify NCAs to make them enforceable. Acceptance of term limitations of up to two years. The new employer may be sued by the former employer, based on complicity of violation of a contractual obligation.

Belgium By virtue of t article 1134 of the Civil Code, an NCA which is agreed upon according to the articles of the act of 3 July 1978, has force of law between the parties. Broad definition of business interest. Special non compete clauses can apply Compensation must be at least half of most recent remuneration. Minimum salary for NCA to apply. A covenant which does not meet the legal conditions is not absolutely void. The validity of the covenant shall not exceed twelve months. An exception may be made when the undertaking either has its own research service or has an international business or major economic, technical or financial interests on the international market. The exception, subject to the procedures and conditions to be fixed by agreement reached within the National Labour Council. Specific rules regarding non-compete clauses apply for sales representatives.

China China’s Employment Contract Law 2008 contemplates the use of NCAs. Requires compensation and limited to the employer's senior management personnel, senior technical personnel and other persons with an obligation of confidentiality Local enforcement discretionality – limited information. The review of judicial enforcement of non-compete and secrecy provisions in labour agreements by Pagnattaro (2007) illustrates the willingness of Chinese courts to enforce the law. The general rule seems to be that agreements with a maximum duration of two to three years will be enforced. (Note: Hong Kong has common law-based, light enforcement rules)

Spain Generic requirement for suitable/adequate compensation, which, according to case law, means 40 to 50 per cent of the employee’s salary. Allows limitation of up to 2 years for “technical workers”, 6 months for others. Rather broad definition of business interest.

Italy Article 2596 of the Code requires that any NCA must be made in a written form and is enforceable if it is limited to a geographical area or a business activity. The term of the noncompetition obligation must not exceed five years. A non-compete clause remains valid notwithstanding the reasons for termination of the contract and their fairness or otherwise. Therefore, under Italian law a non-compete clause should remain in force in the case of resignation by the employee, dismissal of the employee, or mutual termination by both parties. Some compensation is required.

Japan The majority view among scholars is that non-compete obligation should be explicitly written in the agreement, while term, area and prohibited actions should be limited to a reasonable extent. Fair compensation should be paid by the employer. Courts have taken more flexible approach based on the facts of each case. Termination rules can include provision for the reduction or non-payment of a retirement allowance in the retirement rules.

Korea No Korean law provides comprehensive guidelines regarding the enforceability of NCAs. Restrictive covenants are contractually valid and enforceable, subject to the “catch-all” clause of Article 103 of the Civil Code. Courts have held that general knowledge or skills acquired through work does not constitute a trade secret. Also, even if an employee violates a valid restrictive agreement and attempts to use his or her employer’s trade secrets, the employer must prove infringement. The courts have generally upheld terms of one to two and in certain cases three years for restrictive agreements. There may be situations, however, where such terms are not reasonable. On the other hand, a much longer term may be reasonable to protect a particularly valuable trade secret. Courts have recently held that additional compensation beyond regular wages is an important, but not decisive, factor used to evaluate the NCA enforceability

United States (Florida)

Section 542.335 of the Florida Antitrust Act governs the enforceability of covenants not-to- compete entered into on or after July 1, 1996. FLA. STAT. § 542.335 (2004). Acceptance of time limits beyond one year, more if trade secrets are involved. Broad definition of interest. Florida courts are empowered to reform overbroad covenants to the extent necessary to bring them into compliance with the governing statute.

Source: OECD, based on multiple sources.


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4. The impact of enforcement rules for non compete agreements

51. As illustrated in the previous section, economists and legal scholars have recently begun to collect relevant data on NCAs and design empirical tests for assessing the impact of legal restrictions on barriers to employment mobility. The generic purpose of these studies is to go beyond the anecdotal evidence that typically arises in the context of static comparisons between California and other locations and provide a more thorough explanation of how NCAs impact on key personal and economic outcomes of interest. When looking at the impact of NCA enforcement, it is important to consider the implications for a wide range of parties, not only those directly involved in a given mobility episode. Regulations governing NCAs are likely to be complex and have systemic implications as they impact both on the supply of and demand for innovation inputs.

The enforcement of non compete agreement and job mobility

52. Much of the empirical literature on this topic is inspired by Gilson’s (1999) attribution of easy worker mobility in Silicon Valley, previously discussed by Saxenian (1994), to California’s statute prohibiting non-compete agreements. Fallick et al. (2005) find higher rates of job mobility for college educated men in various Californian clusters (including Silicon Valley) computer industry than in computer clusters located out of the state, suggesting a role for state-wide regulations which they attribute to laws restricting non-compete agreements, since mobility rates are comparable for Silicon Valley and other Californian clusters. Fallick et al. (2005) also identify a number of conditions under which the benefits from increased mobility can offset their deleterious impacts on human capital investment by incumbent firms. When the process of innovation is modular, rival suppliers can pursue simultaneous and independent innovation strategies as long the resulting components confirm to the design rules that integrate components into final products. In this case, mobility facilitates the ultimate adoption of the optimal solution. In the case of computers, for example, the advantages of having multiple independent and simultaneous experiments are largest when the gains to innovation are both large and uncertain. (Baldwin and Clark, 1994).

53. Marx (2011) was able to identify a relationship between the probability of moving to a different industry and the prior existence of a non-compete agreement, suggesting that their existence constrained the choice of potential moves, leading them to change careers. A quarter of these career detours were explicitly driven by the need to comply with the NCA and in only a single case was there an explicit threat to sue by the former employer. While it is difficult to generalise from the experience of a very narrowly-defined sector and such a small population, this provides a relevant illustration of the potential difficulties experienced by technical workers subject to NCAs. To address such limitations, Marx’s cross-industry survey of IEEE members shows that nearly one third of respondents who had signed non-competes and subsequently changed jobs reported taking a job in a different industry. Garmaise (2011) finds that increased enforceability and actual enforcement lead to fewer executive moves within-industry, while not between-industry moves. They also find higher enforcement regimes to be associated with a lower departure hazard.

54. Marx, Strumsky and Fleming (2009) exploited Michigan’s inadvertent repeal of a clause banning the enforcement of NCAs to study the impact of NCAs on within state mobility by comparing its change in performance against a synthetic indicator compiled for states that maintained their non-enforcement policy. They found the enforcement of noncompetes to attenuate mobility of inventors, mostly those with firm-specific skills and those who specialise in narrower technical fields. Marx, Singh and Fleming (2010) subsequently investigated whether the Michigan’s natural experiment provide evidence of inventors being driven away from enforcing jurisdictions in order to avoid the enforcement of NCAs. They found evidence of “brain drain”from states that enforce employee NCAs to those that do not, particularly for those with greater human and social capital.


30

55. Marx, Matt and Lee Fleming (2012) interpret this evidence as supportive of NCAs having a pre-emptive blocking impact on individual careers, which they describe as a ‘chilling’ effect on mobility given the uncertainty of future court decisions should the worker choose to move and work for a competitor. Furthermore, they argue that the communication of NCAs by firms at a later stage than the acceptance of a formal job offer is irrelevant to the rationale of NCAs as tools to protect trade secrets and conclude that it is solely intended as a strategy to improve the company’s bargaining position vis a vis the employee.

56. This conclusion is apparently consistent with the study by Garmaise (2011). Using cross sectional variation in enforceability across states (combined with a measure of in-state competition) and observed changes in enforceability in a limited number of states, he showed increased enforceability to be not only associated with fewer executive within-industry transfers, but also lower and more salary-based compensation and reduced post-transfer compensation.25

57. Png (2012) has examined the movements of US patenting inventors between employers within states in relation to a different measure of enforceability based on the accumulation of legal cases. He finds some evidence of NCA cases reducing employee mobility, but that the additional inclusion of a secrecy case stock measure as an explanatory factor of inventor mobility attenuates the observed negative correlation between the stock on NCA cases and mobility. He concludes that the accumulation of trade secrets case law within US states served to inhibit the movement of inventors and had a bigger impact than NCA cases, although the measure used could just reflect a combination of cases resulting in opposite outcomes.

Figure 11. Inventor mobility and non competes As percentage of inventors who moved jobs in previous 5 years (left scale, bars) and NCA average score (right scale)

Source: OECD, based on INNO S&T (PATVAL2, EPO priority date 2003-2005) and PATVAL studies. For previous PATVAL (EPO priority date 1993-1997), data available only for 6 countries and mobility refers to having moved jobs at least once during their career.

58. While it is not possible to estimate a causal relationship between mobility and NCA enforcement across countries, the new experimental indicator introduced in the previous sections can be potentially used to investigate the potential existence of systematic data patterns. One example of such an exercise is portrayed in Figure 11 above, using data from two recent surveys of inventors displayed in European patents (InnoS&T, 2012). The correlation between inventor mobility and the NCA enforceability indicator 25 . He also found evidence of lower R&D spending and reduced capital expenditures per employee.

0

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6

7

0%

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20%

30%

40%

50%

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for the countries for which both measures are defined is minus 31% (p-value 15%), suggesting a potential but only mild connection between the two, notwithstanding the “outlier” effect of Luxembourg, where both mobility and NCA enforceability are reported to be very low26, and the omission of the United States which exhibits considerable heterogeneity across states. A patent count-weighted average would contribute towards placing the United States towards the left hand side of the chart given the relative importance of California in such a calculation.

The impacts on enterprise, venture capital and innovation

59. A very recent review of the available literature on the impact of regulations on innovation is available in Jones (2012). There is a general view that it is currently unclear how the complex legal and regulatory bundles that comprise labour laws affect the functioning of changing labour markets and whether they impact positively or negatively on the processes of different types of innovation, diffusion and productivity growth. Much of the literature does not look specifically at the impact of labour legislation on productivity and other outcomes, through innovation. Menezes-Filho and Van Reenen (2003) focused on the extent to which unions are allowed to operate and surveyed the existing literature for their effects on innovation, noting that while U.S. studies find a negative impact of unions on innovation, European studies do not support these findings. Acharya et al (2009) investigate the impact of a set of labour laws on innovation, as captured by patents and citations using a time-varying index of labour laws in the US, UK, France, Germany, and India. They find that innovation is fostered by more stringent labor laws –amongst which there is no control for the enforceability of NCAs- especially by laws governing dismissal of employees. They also find that stringent labour laws disproportionately influence innovation in the more innovation-intensive sectors of the economy. Bassanini and Ernst (2002) look at the combined effect of IPR protection, employment, and product market regulations across countries. The analysis, which focuses on measures of R&D intensity and patenting, provides some evidence that enhanced competition in the product market -- while guaranteeing intellectual property rights -- seems to have a positive impact on the innovation performance of a country. Conversely, the relationship between innovation and job protection seems ambiguous. The sign and magnitude of the effect of the latter crucially depends on the systems of industrial relations and the specific characteristics of each industry. Indeed, the larger the scope for resorting to internal labour markets, the lower the adjustment costs imposed by labour market regulation.

60. The availability of new information on the regulatory framework as it applies to the enforcement of non-compete agreements could be a valuable addition to the available set of indicators that map the extent of employment protection legislation27 and product market regulation28. The correlation between the new indicator on NCA enforcement and employment protection legislation is virtually nil, whereas there is a negative correlation between stricter enforcement of NCAs and available measures of barriers to entrepreneurship, particularly administrative burdens on start-ups (-40%) and barriers to competition (-20%).

61. The mechanism through which NCAs and their enforcement may impact on enterprise and innovation is a more complex one than just mobility. Employees may wish to leave to set up their own firm or work for competitors who are developing new products, hence NCAs may discourage entry. However, it is important to note that potential entrants will not only consider their ability to attract the necessary human resources to develop their new idea but also their ability to retain their workforce against potential

26 . Luxembourg only appears to restrict the use of NCAs in the case of mobility to another employer, not for

new entrepreneurs. See Table 2 above.

27 . www.oecd.org/employment/protection

28 . See Wölfl, A., I. Wanner, T. Kozluk, G. Nicoletti (2009)


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competition from less credit-constrained incumbents. In principle, entrants can address this risk of low enforcement environments by offering employees a bigger upside on the firm’s outcomes which are tied to the employment relationship. Stuart and Sorenson (2003) showed, for the particular case of the biotech industry, that the enforcement of NCAs appeared to discourage the founding of new firms following liquidity events such as acquisitions or IPOs. These events appear to allow high-level employees to sell their equity holdings, leave and start a new company, most likely in the same or related industrial domain as the predecessor company. Urban areas in states that refuse to enforce NCAs appear to experience higher rates of new venture formation in the biotechnology sector than do states that side with employers in the enforcement of these contractual provisos. The results also show that enforcing non-compete covenants attenuates the link between liquidity events and new venture formation: the positive effect of liquidity events on the local founding rate emerges only in states that do not impede inter-firm employee mobility by upholding contractual restrictions on the freedom of individuals to join competitors of their current employers.

62. The risk of knowledge misappropriation and its incentive effect is one of the key arguments in favour of enforcing NCAs. Garmaise (2009) looked into this question but found that R&D investment among publicly traded firms was lower when NCAs were enforceable, arguing that this was a result of discouraging employee effort and its complementarity with firm investment.

63. It has been argued that the heightened potential for employee departure may introduce uncertainty into an acquirer’s expectations about the return potential of the acquisition: if a target firm’s employees are more likely to leave after an acquisition, the firm will be less attractive to acquirers and acquirers will be less likely to bid for the firm. Younge, Tong, and Fleming (2011) use the Michigan “experiment” to test this hypothesis. They show a significant increase in the likelihood of Michigan firms becoming an acquisition target after non-compete enforcement was strengthened by legislative changes in 1985. They also provided evidence that the effect was stronger when the firm was exposed to greater risks of employee mobility, such as when the firm employs more knowledge workers in its work force and when it faces greater in-state competition. By contrast, the effect is weaker when the firm is protected by a stronger intellectual property regime that can mitigate knowledge loss due to employee mobility. Younge and Marx (2012) subsequently found that enforceable non-compete agreements boosted companies’ Tobin’s q by 26-30% in the short run, a result that is robust to a number of alternative specifications and placebo tests.

Table 4. Venture capital “hotbeds” and the enforcement of non-competes

Region Amount raised in 2011 (US$ million)

Non-competes enforced

Silicon Valley 12592 No New England 3818 Yes South California 3327 No New York metro 3003 Yes, lightly Beijing 2860 Yes UK 1747 Yes, lightly Shanghai 1278 Yes Potomac 1224 Yes France 1026 Yes Canada 993 Yes, lightly Germany 665 Yes Israel 590 Virtually no Switzerland 347 Yes Bangalore 346 No

Source: Ernst & Young (2012), based on Dow Jones VentureSource, 2012, and OECD.


33

64. From an international perspective, it is only possible at this point to carry out a very generic examination of the association between the experimental enforcement measure and key variables of interest. At first glance, it is not just US states that do not enforce NCAs that appear to be over-represented in the list of regions most attractive to VC investment. As Table 4 above, shows, not only do Silicon Valley and South California take two of the top three VC hotbeds (as measured in absolute values), but also Israel and the Bangalore region do make it into the top 14, alongside other countries and regions that have what appears to be a light approach towards enforcing NCAs. Instead of absolute values, Figure 12 looks at VC levels relative to GDP, suggesting a possible negative relationship between VC intensity and NCA enforcement, although this should clearly not be interpreted as a causal relationship.29

Figure 12. Venture capital investment (2009) and NCA enforcement

Venture capital investment as a percentage of GDP versus NCA enforcement score

Source: OECD and OECD (2011), Entrepreneurship at a Glance 2011, based on OECD Entrepreneurship Financing Database, June 2011.

65. In one of the few academic articles that downplays the role of NCAs, Cheyre et al (2012) argue that the greater mobility of semiconductor inventors in Silicon Valley was due primarily to spinoffs and not the clustering of the semiconductor industry there or California’s ban on the enforcement of employee non-compete covenants. To the extent that greater inventor mobility benefited Silicon Valley semiconductor producers, the benefits were mainly experienced by entrants and not incumbent producers.

66. Knowledge diffusion and its potential for driving positive knowledge spillovers over and above any loss of the former employer are key arguments presented in favour of preventing the enforcement of restrictive covenants. The argument is that the potential for positive knowledge externalities will be lower in regions that enforce NCAs. In their analysis of knowledge flows based on patent citations, Singh and Marx (2011) consider the possibility that institutional factors such as the enforcement of employee NCAs 29 . The chart also excludes the case of Luxembourg, which has different regimes for employees who start up

their own business.

ISR

USA (Average)

SWECHE

IRL BELFIN

NORAUSDNK FRAGBR

NLDAUTCAN DEUKOR

PRTESPCZE ESTGRC

ITASVN HUNPOL0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

20%

1 2 3 4 5 6 7


34

might play a role in shaping knowledge diffusion patterns and show that within-state localization of knowledge flows for Michigan fell significantly following the repeal of its ban on noncompetes, relative to the trends one would expect in the knowledge flow patterns by looking at how knowledge flows evolved for other non-enforcing states.

Exploring the impact of changes in US states on R&D and patents

67. We exploit the data on changes in enforceability of NCAs across US states for the period 1991-2009 to investigate the relationship, not necessarily causal, between enforcement and two typically used proxies for innovation, R&D expenditures and patents granted. A simple difference-in-differences approach is used comparing states that increased (decreased) their relative degree of NCA enforcement vis a vis changes in the variables of interest. The regression results reported in Table 4 below correspond to very simple specifications in which only a limited number of controls are accounted for and no real instrument exists for identifying the causal impact of policy changes on the innovation measures. To the extent that those changes may have been driven by groups with significant interests in the outcomes, the results would be biased in either direction.

Table 5. Changes in NCA enforcement rankings, R&D and patenting US states, 1991-2008/9

Change Log R&D

Change Log R&D

Change Log R&D

Change Log R&D

Change Log

Patents

Change Log

Patents

Change Log

Patents

Change Log

Patents

Change Log

Patents

Change Log

Patents 1 2 3 4 5 6 7 8 9 10 NCA 0.002 0.005 0.005 0.006 0.002 0.001 0.001 -0.020 -0.020 -0.023 Change rank (0.002) (0.002)* (0.002)** (0.003)* (0.005) (0.005) (0.005) (0.003)** (0.004)** (0.004)** ChRank* -0.001 0.028 0.027 0.028

MidPat91 (0.004) (0.005)** (0.005)** (0.005)** ChRank* -0.001 0.031 0.031 0.035

HighPat91 (0.006) (0.007)** (0.006)** (0.006)** Log R&D91 -0.059 -0.524 -0.528 0.264 (0.019)** (0.290) (0.294) (0.097)** LogR&D912 0.065 0.065 (0.049) (0.049) LogPat91 0.023 0.044 0.236 0.093 -0.181 (0.055) (0.517) (0.520) (0.414) (0.097) LogPat912 -0.004 -0.036 -0.006 (0.095) (0.098) (0.079) Change 0.326 0.507

LogR&D (0.109)** (0.114)** Intercept 0.457 0.869 1.425 1.433 0.254 0.193 0.167 -0.135 -0.126 -0.334 (0.032)** (0.141)** (0.411)** (0.419)** (0.031)** (0.153) (0.675) (0.671) (0.518) (0.169) R2 0.00 0.13 0.15 0.15 0.01 0.01 0.01 0.28 0.39 0.47 N 51 51 51 51 51 51 51 51 51 51 Source: OECD. Analysis based on enforcement ranking change data in Bishara (2011), USPTO state-level patent data for 1991 and 2009 http://www.uspto.gov/web/offices/ac/ido/oeip/taf/cst_utlh.htm and NSF National Patterns of R&D Resources 2012 (2004) for 2008 (2001) R&D data. http://www.nsf.gov/statistics/natlpatterns/. Note: Ordinary least squares regression results resported. * p<0.05; ** p<0.01 Robust standard errors within parentheses. In the final specification, the net coefficient for “ChangeRank” for the high patent group is 0.012 (=ChRank+Interaction) (SE=0.004**)

68. The “Change Rank” variable is on its own positively related to both changes in R&D and patents, although the effect is not statistically significant (cols 1 and 5). In the case of R&D, accounting for the fact that R&D grows proportionally more in states with lower R&D levels at the beginning of the period leads to more precise estimates of the impact of NCA enforcement rank (cols 2-4). It is not possible to identify to what extent this is driven by R&D conducted by either existing or firms newly set-up or moving into a


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given region from another one. In the case of patents, we do not observe any sort of convergence in performance as observed for R&D, as the difference between the log of patents granted in a state in 2009 and that in 1991 is unrelated to the 1991 level. What we do see is that the changes in enforcement intensity appear to have a different impact among regions with initially high or low numbers of patents. Thus a relaxation in the number of patents in states with initially high number of patents is observed to be *liked with faster growth in patents granted, while a similar shift for initially low patenting states appears to be associated with a lower growth in patents. This result is too broad to be interpreted as evidence of any particular mechanism through which NCA enforcement impacts on innovation in a given region or state.30

Patents provide an indicator of the outcome of innovation efforts but patenting intensity can also increase in response to a perceived need to protect the company’s inventions. Thus an increase in the patenting rate may be due to an increasing difficulty in protecting secrets as a result of reduced enforceability. Further checks are needed to assess to what extent this applies to patents in different technology classes.

69. These results appear to be consistent with those in Samila and Sorenson (2011), who found that US states that enforce NCAs experience a lower return on venture capital investment. A potential limitation of this study is only the potential endogeneity in the supply of venture capital is managed through an instrumental variable, while there could be other unobserved state-level factors that drive the observed interaction relationship.

5. Implications for policy analysis and concluding remarks

70. Governments worldwide seek to understand what role regulations play a role in setting the framework conditions that create the conditions and dynamics most conducive to promoting innovation and entrepreneurship. Anecdotal experiences from certain clusters and industries, including perceived failures and successes, weigh heavily in the search for policy prescriptions which do not necessarily entail increased and sustained levels of public funding. However, the shortage of robust evidence is a clear limiting factor to drawing policy recommendations. Most analytical efforts to evaluate the impact of policies on innovation usually focus on the role of subsidies, public funding of research and related programmes. As noted in the previous section, international comparisons can provide a relevant source of evidence on the role of regulations, but they do require time intensive efforts to codify what can be rather subtle legal rules and enforcement practices, whilst taking into account a wide range of competing factors which can account for observed differences in innovation and economic performance. The evidence presented in this report suggests that there are highly relevant dimensions of employment-related regulations for innovation which are currently omitted from existing international indicators and analyses. Marx and Flemming (2012) argue that non-competes are “an underappreciated lever for policymakers to wield in effecting entrepreneurial outcomes”. Their existence and impact may not be fully appreciated by academics and officials who are to a large extent not subject to such restrictive post-employment themselves.

71. There is ample evidence that non-compete clauses have become an essential part of contemporary employment contracts for highly skilled knowledge workers. As much of business knowledge is of a tacit nature, residing primarily in the minds of workers, this is leading firms to use employee non-compete agreements to prevent leakage through inter-organisational mobility, as employee departures may potentially boost the capabilities of rivals to the detriment of their own competitive advantage. However, allowing a broad use of restraint of trade practices in the context of the employment market may present an insurmountable obstacle for new, more productive and innovative firms, to source 30 . Furthermore, a complete analysis should focus on the R&D and patenting carried out in companies and

organisations for which the enforcement of NCAs is applicable.


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the necessary human resources to bring their ideas to fruition, while distorting the ability of markets to redeploy resources to the activities in which they are likely to be most productive.

72. The review of the existing and predominantly US-centric literature and the initial analysis of variability in enforcement across countries are overall supportive of the conclusion that there is significant public interest in ensuring a basic degree of mobility among the highly skilled. For example, it has been noted that implementing programmes to promote venture capital without a sufficiently supportive framework for knowledge flows -including supportive employment laws and enforcement- may have little chance of longer-term success, even if they temporarily succeed in increasing the level of venture capital activity. The reality is however complex and there is no straightforward answer to policy makers on whether they should ban the enforcement of NCAs. The literature confirms the existence of considerable trade-offs across objectives that policy makers should take into account. In their recent review of the key issues and US literature, Marx and Fleming (2012) point out, despite their own critical view on the enforcement of NCAs, that no full welfare analysis has been carried out that yields a definitive answer regarding whether non-compete enforcement has net positive or negative effects.

73. The study of NCAs and their economic impact highlights the importance of assessing the systemic nature of the innovation system. While investment in innovation by any given firm may be encouraged through the strict enforcement of NCAs, this may not be necessarily optimal from the perspective of the system as a whole if the circumstances are such that the benefits arising from higher human resource mobility and knowledge flows outweigh the impact on the specific incumbent. The regulation and enforcement of non-compete agreements lie at the complex intersection of employment, IP, contract and competition law. These various strands of law need to be considered as a whole body that shapes the relationships within the innovation system and the investment decisions of firms and individuals.

Policy implications

74. Rather than identifying an “ideal” policy on non competes, the evidence contained in this report suggests that policy makers could begin by considering which are the key asymmetries between the various parties, in terms of market power and access to information, that lead to the most significant distortions, in order to propose solutions. Some potential elements for policies to consider include the following:

• Address key asymmetries at the onset of the employment relationship. There is evidence that new employees, particularly younger and less experienced ones, are not fully informed about the implications of non-competes and are sometimes coerced into accepting them after they have refused other potential offers. If they choose to enforce NCAs, governments could consider mandating a more open and transparent approach by employers which ensures that employees are aware of the potential implications for their careers.31 This would not impinge on companies’ ability to protect their knowledge assets.

• Assess the whole array of employment market regulations that impact on mobility, and assess the potential impact of barriers to mobility or “loyalty” incentives for the knowledge flows between firms, organisations and countries.

− Specifically consider the circumstances that apply to researchers, technical workers and designers, and how the potential for employers to restrain their careers can lead to risk

31 . In the United States, the New Hampshire legislature passed in 2012 a new state law that requires the

disclosure of non-compete and non-piracy agreements to potential employees prior to making offers of new employment and to existing employees with an offer of change in job classification.


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aversion, excessive preference for “academic” careers or investing in generic skills. These factors can influence the direction of individuals’ careers, and deter them from adopting more “entrepreneurial” decisions, such as to proceed with careers in highly specialised research fields, or moving after a doctorate degree into the single firm which develops a given technology for which the research is relevant.

− Consider what mechanisms may be used to prevent the use of NCAs to immobilise employee skills gained prior to the employment relationship. Employees need to be assured that the enforcement of NCAs will be such that the skills that they bring into a job will not be locked in the future if they choose to quit their employers.

− Recognise the conditions in which NCAs may be potentially useful for entrepreneurs. At present there is not sufficient direct evidence to understand which types of firms are more favourable to the enforcement of NCAs. NCAs are typically thought to disadvantage new entrants by making their hiring of existing staff more difficult, but in some cases, by preventing their enforcement, this may inadvertently result in making it more difficult for start- ups to retain their employees against incumbents able to offer higher and more certain salaries and entice them away from innovative firms.32 Policy makers should consider whether the system allows enough flexibility for entrepreneurs to provide their employees with an upside on the business’ future performance as a positive encouragement to loyalty in firms which would otherwise struggle to retain their employees. Certain features of the accounting, tax and public and private pensions systems can be highly influential in driving these incentives.

• Address asymmetries between available remedies and potential / actual damage to business interests. Although NCAs help address the difficulties in verifying some forms of knowledge misappropriation which baseline trade secret legislation may not be able to address, the enforcement of non-compete agreements should not provide an excessively broad basis upon which companies protect themselves from any type of competition from their former employees.

− Design better-tuned instruments to protect trade secrets and other business intangibles. Given the ample evidence of the interplay between NCA and trade secret legislation, no reform of one single system should be attempted without consideration of the other. A possible downside of a sudden ban on NCAs is an increased pressure on the court system dealing with trade secrets and confidential information. A system that prevents the use of non competes, may need to have in place a highly robust and sophisticated set of arrangements for dealing with protecting trade secrets, or a business culture in which such type of protection is not too aggressively pursued.

− Better informed SMEs on trade secret protection. Policies can help promote a better understanding, particularly within SMEs, of relevant and lawful practices to protect their trade secrets in order to minimise their need to resort to blunt and potentially more distorting non-compete assertion tools.

32 . Some observers (see http://lawprofessors.typepad.com/antitrustprof_blog/files/israeli_antitrust.pdf) have

indeed noted that the banning of NCAs is not necessarily in the interest of enterprise and competition. In Israel’s “Checkpoint” case in particular, the previous employer (Redguard) was a small firm wishing to expand and compete with the incumbent (Checkpoint) in the market for security firewalls that protect computer networks.


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− Manage the uncertainty associated with decisions by courts by setting clear guiding principles regarding what practices are deemed to be reasonable, allowing flexibility to implement decisions that promote economic efficiency. Policy makers should consider for example the extent to which courts can systematically recognise differences across types of industries and apply economic efficiency arguments in relation to the trade-off between knowledge mis-appropriation on the one hand, and knowledge spillovers and competitive churn effects on the other.

− When considering term limitations to the enforcement of NCAs, the legal system needs to consider how quickly knowledge and skills become obsolete and the potential differences across types of employees and industries. A fixed maximum term limitation may have unintended effects. For example, setting a maximum legal term of say, one year, may unnecessarily provide a focal default position. This could results in an excessive term for a large proportion of employees for whom a shorter term may be more appropriate in the light of the rate of technical change in that domain.

• Give consideration to the wider culture of mobility and prevailing social norms in professions and industries. Policy makers should not ignore the practical importance of social-based practices and norms. Norms based on trust and repeated relationships are basic mechanisms used by firms in many sectors to manage knowledge flows and addressed potential misappropriation problems. While these norms increasingly come under challenge in a globalised, competitive environment, they appear to be successful in some circumstances. In principle, policy makers can encourage the use of norms that promote loyalty to the local innovation system while ensuring sufficient competition within it. Policies could favour arrangements whereby departing employees would self-certify that they will not misappropriate former employers’ knowledge assets and employers can provide a supportive approach to their employees’ internal and external careers. Taking into account the negative impact of the current economic downturn, policy makers should also be aware of decisions that may penalise employers who retain their skilled workforce against challenging market conditions.

• Monitor ongoing changes in the marketplace. Policy makers should consider the implications of the internet and social networks in particular for new regulations and practices in this domain. Many employers, particularly those in sales or recruiting, encourage their employees to create profiles on sites such as LinkedIn, and many employees depend upon those sites for their regular work. While those sites can have significant benefits for employers and employees, the departure of an employee and subsequent status update can lead to an implicit breach of non compete and non solicitation agreements. The fundamental question at stake is not only who owns the employee’s contacts and whether they have been created in the context of the employment activity, but also what can be reasonably and feasibly enforced by authorities. Former employers can be reasonably concerned about the potential liabilities implied by the ease with which clients can remain in touch with the departed employee. Courts and legislators will increasingly have to face the effects of social networking in workplaces and address the enforceability of clauses included by firms to protect themselves.

• Consider the international / inter-jurisdictional dimension of non-compete agreements: Policy makers should note the diversity of practices across countries, particularly in emerging economies.

− Decisions regarding the enforcement of NCAs can impact, at the margin, on the location decisions of certain types of firms and employees. From the perspective of employers, higher enforcement levels may make some locations more attractive to economic activities that rely


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on long-term stable employment with a single employer and career progression through a series of interconnected jobs within a hierarchy, where work related skills are generated through firm-specific on-the-job training. Lower enforcement areas may, for the reasons already discussed, be more attractive for fast growing industries facing limited supply of relevant skills and rapidly evolving technology without a predominant design or standard.33

− From the perspective of employees, low enforcement jurisdictions may attract employees wishing to move away from NCA constraints if those cannot be applied locally. Based on international agreements and EU law34, some countries allow foreign employers to execute judgements delivered in the jurisdiction of the former employer, although permission to do so appears to be rarely granted, especially if local regulations differ.

− SMEs and employment markets in an international context. SMEs may lack the means and information to procure the right assistance when entering new international markets. Given the likely need to recruit locally, they should be aware of the need to secure advice on how best to deal with differences across jurisdictions.

Implications for future measurement and research work

75. Despite the relevance of barriers to employee mobility for a wide range of innovation outcomes, there is very little evidence that policy makers can draw up to base decisions on whether to encourage or limit the use of restrictive contractual practices such as NCAs. The analysis contained in this report highlights the lack of relevant evidence on the incidence and impact of non compete agreements outside the United States, where a new wave of empirical studies has recently begun to systematically address their potential impacts by drawing on relevant data sources as well as evidence of policy differences and changes which can be used for comparative purposes. The characterisation of legal practices worldwide surrounding the enforcement of NCAs is a preliminary and highly experimental one that will benefit from the future feedback and comments of experts and practitioners.

76. In terms of empirical analysis, some basic measurement tools still need to be put in place in order to carry out future analyses. Some specific areas in which measurement work within existing measurement frameworks can help provide an improved evidence base comprise the following examples:

• Patent-based statistics of inventor mobility and knowledge flows: Patent data have proved very important to evaluate the extent of employee mobility and the impact of NCAs. Progress towards disambiguating the full range of inventor names in the PATSTAT database, which comprises patents filed within the Patent Cooperation Treaty, would enable an enhanced assessment of inventor mobility across the entire world.

• Policy-relevant information in surveys of human resources for science and technology. One important limitation in current studies is the lack of information on the circumstances surrounding past episodes of employment mobility and the factors limiting potential future mobility. National studies and those carried out in the framework of the Career of Doctorate

33. The policy discussion on NCA enforcement is necessarily tied into the structure of a national system of

competence building and innovation. The features of the system in relation to career mobility have been discussed for example by Lam and Lundvall (2007), who combine education and training systems as narrow 'professional-oriented' vs. broad 'competence-based' and Labour markets and careers as based on occupational or internal labour market.

34. See, for example, the Rome Convention 80/934/ECC and Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I).


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Holders project could consider investigating the role of non-compete agreements and other policy rules in more detail.

• Business surveys. This report set out how innovation surveys carried out under the Oslo manual framework provide relevant information for understanding how knowledge critical for innovation is sourced and protected, but highlighting how little it currently says about the role of employee mobility. Future ad-hoc studies in the form of supplemental modules to innovation or intangibles- related surveys should help identify how companies cope with employee mobility in capitalising their intangible assets and innovation efforts, as well as how they build up capability for innovating by sourcing from other companies.

Concluding remarks

77. To conclude, this report has noted the importance of employee mobility for the efficiency of the innovation system but also its potential negative impacts on the stock of knowledge held by companies and their incentives to invest. Business strategies to protect themselves against some of these flows include the use of non-compete agreements, whose enforcement is tolerated to rather different degrees across jurisdictions worldwide. This report is to the best of our knowledge the first to attempt to document those differences for use by researchers and policy makers interested in evaluating the optimal approach to regulating the flow of skilled employees -and the knowledge they embody- across different organisations. The limited information available at present on the extent to which the benefits and costs of NCAs compare does not warrant a clearcut policy recommendation. This report suggests that policy makers should focus, within their current legal systems, on addressing the key informational and market power asymmetries in the employment and post-employment relationships which may lead to the abuse of NCAs. Addressing the role of institutional barriers to mobility in defining the effectiveness and efficiency of the innovation system beyond individual cases is likely to require a multidisciplinary approach which combines economic, sociological and legal perspectives.

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