Enforcement of Non-Compete Agreements, Outside Employment Opportunities, and Insider Trading

Abstract

Companies often use non-compete agreements to restrict employees from joining or forming a rival company. However, enforcement of non-compete agreements could also affect executive and director incentives to trade on their inside ownership because excessive trading profits could result in termination, which would trigger the restrictions imposed by the non-compete agreements. We find that executives’ and directors’ insider trading profits are lower for companies headquartered in states with greater enforcement of non-compete agreements. This result is stronger for companies with greater product market competition and insiders with more trading. We also find associations between the enforcement of non-compete agreements and lower insider trading volume and lower future earnings surprises. Together, these findings suggest that enforcement of non-compete agreements reduce the trading incentives for executives and directors by imposing costs associated with executives’ and directors’ future outside employment opportunities.