CEO Employment Contracts and Non-compete Covenants

Posted by Randall S. Thomas, Vanderbilt University, on Tuesday November 20, 2012 at 8:57 am
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Editor’s Note: Randall S. Thomas is a John Beasley II Professor of Law and Business at Vanderbilt Law School.

In our recent working paper, When Do CEOs Have Covenants Not to Compete in Their Employment Contracts?, we undertake the first comprehensive study of contractual restrictions on CEOs’ post-employment competitive activities. The large random sample of nearly 1,000 CEO employment contracts for 500 companies was selected from the S&P 1500 from the 1990s through 2010. We find that about 70% of CEO contracts have post-employment competitive restrictions. We also find more covenants not to compete (CNCs or noncompetes) in longer-term employment contracts and at profitable firms. In addition, our study uses a nuanced state-by-state CNC strength of enforcement index to test the variance of CEO noncompetes across jurisdictions.

The value or harm of CNCs is often discussed in the legal and management literature. They are regularly criticized as anti-competitive contracts of adhesion that pit overreaching employers against vulnerable employees. Clearly CEOs are not vulnerable rank-and-file workers forced to take on onerous contractual restrictions to earn a living. Rather, they are the most highly compensated and sought-after employees whose contracts are individually negotiated with the assistance of counsel and therefore CNC clauses in their contracts are unlikely to involve coercion.

Practitioners and researchers alike generally assume that CNCs are widely used by employers, but rarely has this assumption been addressed systematically. Using multivariate regression analysis, we find that CEOs are less likely to have CNCs in their employment contracts if the agreements are being enforced in jurisdictions that do not allow strong CNC clauses. For example, we find that contracts that are likely to be enforced in California where employment noncompetes are virtually banned by statute are much less likely to include non-compete clauses because its state courts will not enforce those provisions. This finding gives credence to the presence of a “California effect” related to CEO mobility.

Another key finding is that there is a significant trend toward greater usage of CNC clauses in CEO employment contracts over time. This increase in CNC use suggests that employers are more aware than ever of the importance of using CNC clauses to protect their investments in human capital. Moreover, if a company used a noncompete in a prior CEO employment contract, then it is much more likely to succeed in adding one in a later contract even with a new CEO leading the firm.

Next, we find that longer-term contracts are more likely to have CNC clauses than short-term contracts. This likely indicates that firms have the confidence to make greater firm specific investment in CEOs that both stay for longer periods and have a contractual restriction on their freedom to leave and compete. Finally, we find that more profitable firms are more likely to use noncompete provisions in their CEO’s employment contract, thus suggesting that for these firms the risk of harm from a departing CEO who is free to compete may simply be more acute than with other firms.

The full paper is available for download here.

  1. Do you have any statistics on the use of CNC’s in contracts with upper middle management positions that have responsibility for significant portions of the entity’s operations but a layer or two below the CEO position?

    Comment by Ray Biggs — November 23, 2012 @ 10:00 am

 

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