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Enforcement of Non-Compete Clauses and Productivity

Enforcement of Non-Compete Clauses and Productivity published on No Comments on Enforcement of Non-Compete Clauses and Productivity

Non-compete clauses (or ‘covenants not to compete’, CNCs) in contracts restrict parties from working or doing business in particular industries or geographic markets for some period of time after the termination of the contract. These clauses seem to be getting more common (even for fast food restaurants). There are some economic justifications for CNCs, particularly if an employee has access to proprietary information that is central to the employee’s role or if things like client lists or industry contacts are key strategic assets. CNCs can help align the incentives of both the employee and the employer–since having those protections may increase information sharing within the firm. My colleague, Harvey James, Jr., has a nice piece (ungated version here) on employment contracts that discusses some of these incentive issues.

Ultimately, however, CNCs are subject to State law and State enforcement–and not all States enforce CNCs with equal rigor. So what are the effects of State enforcement (and thereby, of CNCs themselves)?

A recent study in Human Resource Management by Smriti Anand, Iftekhar Hasan, Priyanka Sharma and Haizhi Wang explores the effect of State enforceability of CNCs on firm productivity.  The results seem rather interesting. The abstract reads:

Noncompete agreements (also known as covenants not to compete [CNCs]) are frequently used by many businesses in an attempt to maintain their competitive advantage by safeguarding their human capital and the associated business secrets. Although the choice of whether to include CNCs in employment contracts is made by firms, the real extent of their restrictiveness is determined by the state laws. In this article, we explore the effect of state-level CNC enforceability on firm productivity. We assert that an increase in state level CNC enforceability is detrimental to firm productivity, and this relationship becomes stronger as comparable job opportunities become more concentrated in a firm’s home state. On the other hand, this negative relationship is weakened as employee compensation tends to become more long-term oriented. Results based on hierarchical linear modeling analysis of 21,134 firm-year observations for 3,027 unique firms supported all three hypotheses.

Certification, Teacher Quality, and Click-bait Academic Publishing

Certification, Teacher Quality, and Click-bait Academic Publishing published on

Today’s email brought a content alert from Economic Inquiry on a newly accepted paper titled “New Evidence on National Board Certification as a Signal of Teacher Quality”. The abstract of the paper reads:

“Using longitudinal data from North Carolina that contains detailed identifiers, we estimate the effect of having a National Board for Professional Teaching Standards (NBPTS) teacher on academic achievement. We identify the effects of an NBPTS teacher exploiting multiple sources of variation including traditional-lagged achievement models, twin- and sibling-fixed effects, and aggregate grade-level variation. Our preferred estimates show that students taught by National Board certified teachers have higher math and reading scores by 0.04 and 0.01 of a standard deviation. We find that an NBPTS math teacher increases the present value of students’ lifetime income by $48,000.” (emphasis added)

Based on the abstract, one might infer that having NBPTS certification makes for a better teacher and that having NBPTS certification allows math teachers to have a meaningful lifetime income effect on students. If you read just a bit further, you might feel comfortable that you made the right inference when you read:

With aggregation and school-by-year fixed effects only variation between cohorts is used to identify the effect of NBPTS on test scores.

Unfortunately, if you concluded that being NBPTS certified has a meaningful relevance to student performance, you’d be completely wrong–as the paper itself explains.

Reading the abstract, the first question one should ask is “How does one become NBPTS certified, and what does that have to do with teacher quality?” In statistical terms, there’s a significant question of endogeneity and causation. Namely, does getting certified make one a better teacher, or do only better teachers get certified? If the latter, then whether or not one is certified has nothing to do with academic outcomes. It might provide a signal that the teacher is already a good teacher, but having the certification would have no meaningful effect on academic outcomes or lifetime earnings.

And indeed, that is exactly the case, as the authors themselves explain if you read just a little further than the statement about their method “to identify the effect of NBPTS on test scores.” What matters is the teacher and the teacher’s skills and practices. The certification itself is superfluous to the academic achievement result.

“Comparisons of teacher performance before and after certification suggest that greater average effectiveness of certified teachers reflects fixed quality differences identified by the certification as opposed to human capital effects. Implementing policies with a primary goal to modify the effectiveness of teachers should place little weight on the NBPTS certification as a potential facilitator. Rather the certification can be used to reward more effective teachers where use of direct evidence on performance in the districts is not feasible.” (emphasis added)

In other words, it’s the teacher-effect, not the NBPTS effect, that matters–to the point that the authors specifically say that little weight should be place on NBPTS certification as a potential facilitator (i.e., a policy tool) for improving student outcomes.

What the authors really purport to show, as the paper title alludes, is that being NBPTS certified is a pretty good indicator that a teacher is a good teacher. The NBPTS standards appear to be well-aligned with effective teaching practices. But if that’s the actual research objective, then the authors should also have looked at the causation from the other direction and tried to sort out the selection bias in who wants to get certified and why.

It’s unfortunate that the abstract of the paper is so misleading, because many people economize on their time by only reading the abstracts of articles to get a sense of the paper’s results. After all, that’s the purpose of an abstract. In this case, however, the abstract is written so poorly that it buries the actual results beneath a misleading presentation and might be perceived as a serious case of ‘bait and switch’. While the title of the paper is still correct–having national board certification is a signal of teacher quality–the abstract’s wording risks painting a false picture of the relevance of certification for student achievement. And that false picture is perpetuated by their description of their methods.

The editors of Economic Inquiry should be a bit ashamed for allowing such a bait and switch. The authors should as well. At best, it’s carelessly poor writing. At worst, it’s the academic equivalent of click-bait. Unfortunately, some people may look no further than the abstract as the basis for what would ultimately be a misguided potential education policy.

 

Corporate Tax Policy and Productivity Growth

Corporate Tax Policy and Productivity Growth published on

An article by Colin Davis and Ken-ichi Hashimoto in the latest Economic Inquiry seems relevant to the current GOP tax reform proposals. The paper, titled “Corporate Tax Policy and Industry Location with Fully Endogenous Productivity Growth,” purports to show the effects of differential corporate tax policy on business location choice, productivity and innovation. The abstract follows:

This paper considers how national corporate tax policy affects productivity growth through adjustments in geographic patterns of industry in a two-country model of trade. With trade costs and imperfect knowledge spillovers between countries, production concentrates partially and innovation concentrates fully in the country with the lowest tax rate. A rise in the international corporate tax differential accelerates productivity growth through an increase in the production share of the low-tax country that improves knowledge spillovers from industry to innovation. The paper also investigates the relationship between the corporate tax differential and the level of market entry, and analytically characterizes the effects of changes in tax policy on national welfare.

Given the U.S. has one of the highest corporate tax rates among developed nations, the results of this study would seem to support efforts to lower that tax rate to be more in line with international peers. And lest the result seem too politically convenient, an ungated copy of an earlier draft of the paper (from 2015) is available here.

Board Independence Gone Too Far?

Board Independence Gone Too Far? published on

The corporate governance literature has long argued that corporate boards should be comprised of a majority of independent directors. This is the result of a simple agency theory argument: Boards comprised of insiders (i.e., firm employees) will put their own interests ahead of the shareholders’. Moreover, any insider other than the CEO may have incentive to accommodate, rather than challenge, the CEO in the boardroom. Independent directors are assumed not to have such conflicts of interest and therefore to be better monitors of management on behalf of shareholders.

This argument, combined with corporate scandals in the early 2000s, has led to both regulatory requirements and shareholder activist pressure for increased board independence–to the point that many firms now have only one insider on the board, the CEO. That’s well beyond the theoretical justification for increased independence. But is it actually a good thing for the CEO to be “home alone” as the sole insider on the board? Has the push for board independence gone too far?

A forthcoming paper in the Strategic Management Journal by Michelle Zorn, Christine Shropshire, John Martin, James Combs and David Ketchen, titled “Home Alone: The Effect of Lone-Insider Boards on CEO Pay, Financial Misconduct, and Firm Performance,” suggests that such extreme independence is actually a bad thing. The abstract follows:

ABSTRACT

Research summary

Corporate scandals of the previous decade have heightened attention on board independence. Indeed, boards at many large firms are now so independent that the CEO is ‘home alone’ as the lone inside member. We build upon ‘pro-insider’ research within agency theory to explain how the growing trend toward lone-insider boards affects key outcomes and how external governance forces constrain their impact. We find evidence among S&P 1500 firms that having a lone-insider board is associated with (1) excess CEO pay and a larger CEO-top management team pay gap, (2) increased likelihood of financial misconduct, and (3) decreased firm performance, but that stock analysts and institutional investors reduce these negative effects. The findings raise important questions about the efficacy of leaving the CEO ‘home alone.

Managerial summary

Following concerns that insider-dominated boards failed to protect shareholders, there has been a push for greater board independence. This push has been so successful that the CEO is now the only insider on the boards of more than half of S&P 1500 firms. We examine whether lone-insider boards do in fact offer strong governance or whether they enable CEOs to benefit personally. We find that lone-insider boards pay CEOs excessively, pay CEOs a disproportionately large amount relative to other top managers, have more instances of financial misconduct, and have lower performance than boards with more than one insider. Thus, it appears that lone-insider boards do not function as intended and firms should reconsider whether the push towards lone-insider boards is actually in shareholders’ best interests.

Franchising and Firm Performance

Franchising and Firm Performance published on

Much of the research on franchising as an organizational form relies on an agency theory explanation. In short, it assumes operators of local franchise establishments will have greater incentive to operate efficiently if they are owners of the establishment (i.e., franchisees) rather than managers employed by the franchisor-owner. However, there isn’t a lot of empirical research substantiating that assumption. Matt Sveum and my recent working paper finds that there does appear to be a franchise effect–but it depends on the nature of the business format. We use US Census data for essentially all limited- and full-service restaurants in the US and find franchising explains differences in establishment performance for full-service, but not for limited-service, restaurants. The abstract follows:

While there has been significant research on the reasons for franchising, little work has examined the effects of franchising on establishment performance. This paper attempts to fill that gap. We use restricted-access US Census Bureau microdata from the 2007 Census of Retail Trade to examine establishment-level productivity of franchisee- and franchisor-owned restaurants. We do this by employing a two-stage data envelopment analysis model where the first stage uses DEA to measure each establishment’s efficiency. The DEA efficiency score is then used as the second-stage dependent variable. The results show a strong and robust effect attributed to franchisee ownership for full service restaurants, but a smaller and insignificant difference for limited service restaurants. We believe the differences in task programmability between limited and full service restaurants results in a very different role for managers/franchisees and is the driving factor behind the different results.

Medical Malpractice Data and Inquiries

Medical Malpractice Data and Inquiries published on

The current issue of Journal of Empirical Legal Studies includes an interesting data resource and survey by Bernard Black, et al., titled Medical Liability Insurance Premia: 1990–2016 Dataset, with Literature Review and Summary Information. Having just talked briefly about med mal premia and healthcare regulation last week, I was interested to read through the review and description of some of the data and trends. The authors have compiled data from the Medical Liability Monitor, “the only national, longitudinal source of data on med mal insurance rates.”  But they don’t stop there.

We link the MLM data with several related datasets: county rural-urban codes (from 2013); annual county- and state-level data on population (from the Census Bureau); number of total and active, nonfederal physicians, with a breakdown by specialty (from the Area Health Resource File, originally from the American Medical Association); annual state-level data on paid med mal claims against physicians from the National Practitioner Data Bank (NPDB), available through 2015; and data on direct premiums written by med mal insurers from the National Association of Insurance Commissioners (NAIC), available through 2015. We also provide a literature review of papers using the MLM data and summary information on the association between med mal insurance premia and other relevant features of the med mal landscape.

The data appendix, public data, and STATA code book (for cleaning the dataset) are also available from SSRN here. The survey includes a summary of some research into possible explanations for and consequences of medical malpractice premia: effect of med mal risk on healthcare spending, effect of med mal reform on med mal premia, effect of med mal rates on C-section rates and physician supply, effect of med mal payouts on med mal premia.

Noticeably absent from the literature they summarize, which they claim are the principle prior studies using MLM data, is any attention to or focus on market structure issues. Doubly so since there has been a consistent drop in rates over the past 15 years that is generally unexplained in the cited literature. Now, I don’t specialize in health care industry research, but I do know that in the past 15 years there has been an ongoing trend of consolidation among both health insurance companies and medical providing companies (e.g., hospital networks, physician groups, both).  I could easily hypothesize a couple potential dynamics:

  • Increased consolidation among insurance companies may lead to contractual incentives (by way of contract rates and performance measures) that affect the expected cost of med mal insurance.
  • Increased consolidation among hospital networks and physician groups leads to more consistent or standardized practices across larger populations of patients/services, thereby reducing uncertainty or volatility of medical service provision/quality and, thereby, expected cost of med mal insurance.

I suspect there are several potential channels, but it would seem a potentially fruitful area of research–and now there is a more convenient data set with which to play.

How mergers affect innovation…maybe?

How mergers affect innovation…maybe? published on

Justus Haucap and Joel Stiebale with the Düsseldorf Institute for Competition Economics (DICE) at the University of Düsseldorf have a recent paper analyzing the effects of mergers on innovation in the European pharmaceutical industry. The develop a model that suggests mergers reduce innovation not only in the merged firms, but among industry competitors as well. Their data bear this out, as explained in the abstract:

This papers analyses how horizontal mergers affect innovation activities of the merged entity and its non-merging competitors. We develop an oligopoly model with heterogeneous firms to derive empirically testable implications. Our model predicts that a merger is more likely to be profitable in an innovation intensive industry. For a high degree of firm heterogeneity, a merger reduces innovation of both the merged entity and non-merging competitors in an industry with high R&D intensity. Using data on horizontal mergers among pharmaceutical firms in Europe, we find that our empirical results are consistent with many predictions of the theoretical model. Our main result is that after a merger, patenting and R&D of the merged entity and its non-merging rivals declines substantially. The effects are concentrated in markets with high innovation intensity and a high degree of rm heterogeneity. The results are robust towards alternative specifications, using an instrumental variable strategy, and applying a propensity score matching estimator.

While I haven’t yet read the paper in detail, a cursory examination suggests they have ignored another possibility: mergers in high-intensity R&D industries could be a leading indicator of decreased innovation productivity (i.e., lower returns to investment in R&D). Consider that as research advances, the “low hanging fruit” are collected first before the more difficult (and lower return) investments are pursued. As companies in a high-intensity R&D industry exploit all of the low hanging fruit, particularly internally, one might expect mergers as a way of expanding the available set of lower-cost/higher-return R&D investment opportunities. Since firms are competing in the same science space, a slow-down in one firm is likely to be spuriously correlated with slowdowns throughout the industry.

“Affect” is a word of causation. To suggest that mergers cause a reduction in innovation is a strong statement–especially when paired with a merger policy implication. This may be something that bears more scrutiny since, as the authors note, the entire subject is one on which relatively little light has thus far been shed.

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