Wharton's Peter Cappelli, Duke's Matthew Johnson and Evan Starr from the University of Maryland discuss the recent challenge to no-poaching agreements at franchises.

The practice of “no-poach” agreements in the fast food industry is under scrutiny with a group of 11 Democratic state attorneys-general announcing last week that they are seeking information on them from eight fast food chains including Arby’s, Burger King, Dunkin’ Donuts, Wendy’s and Panera Bread. Franchisors have these agreements with their franchisees in order to prevent employees from leaving one franchise to join another within the same chain. According to Massachusetts A.G. Maura Healey, who is leading the state attorneys-general in this case, “The agreements limit the ability of low-wage workers to seek promotions and earn a better living,” a New York Times report says. The attorneys-general contend that 80% of fast food chains have no-poach agreements. The eight chains have until August 6 to respond.

The legality of non-poaching agreements is suspect, and franchisors take conveniently conflicting positions on when a franchisee is treated as part of their company, said Wharton management professor Peter Cappelli. He raised bigger questions about the fairness of such policies to workers when they are designed to protect employers. The business case for non-poaching agreements is that they help employers protect their investments in training, but they are “invisible” to workers, said Matthew Johnson, a research scientist at the Sanford School of Public Policy at Duke University. Alternatives such as “training repayment contracts” could be explored, and greater wage transparency could be achieved, said Evan Starr, assistant professor of management and organization at the Robert H. Smith School of Business at the University of Maryland.

Cappelli, Johnson and Starr discussed the broader implications of the scrutiny into no-poaching agreements at fast food chains on the Knowledge at Wharton show on Wharton Business Radio on SiriusXM channel 111. (Listen to the podcast at the top of this page.)

Below are key takeaways from their discussion:

Are No-poach Agreements Legal?

Agreements among employers not to hire from each other raise antitrust issues and are “almost always illegal,” according to Cappelli, who is also director of the school’s Center for Human Resources. He noted that informal, unwritten no-poaching agreements have been common among Silicon Valley technology companies, drawing the attention of the U.S. Justice Department. In fact, Apple, Google, Intel and Adobe agreed to pay $415 million to settle a no-poaching lawsuit three years ago.

Cappelli said no-poaching agreements are different from non-compete agreements where employers seek to prevent their employees from leaving to join a competitor. Such “restrictive covenants” are found also in non-solicitation agreements with other employers and non-disclosure agreements that seek to protect proprietary information.

The problem is compounded by the fact that employees of franchisees typically are not aware of no-poaching contracts their employers have with franchisors, and have not given their consent to them. “The big problem here is that all of this is invisible to the worker,” said Starr. “The worker does not agree to this [agreement]. If they don’t get along with their manager, or if they learn that it’s not a good work environment, or perhaps they have to move locations for some reasons, and their skills are basically perfectly transferable to another franchise within that same company, then they’re not able to do that.”

“The big problem here is that all of this is invisible to the worker.” –Evan Starr

Conflicting Positions of Franchisors:

“Franchise companies like McDonald’s and others go to great pains to argue that each business is independent, and part of that is to protect the mother ship from lawsuits that individuals might bring against individual stores or against unionization,” said Cappelli. “On the other hand, they have to argue here that these businesses are really part of one big company or you couldn’t make them enter into these [no-poaching] agreements, which are part of the operating agreement of the franchise.”

According to Cappelli, those apparently conflicting positions raise two questions: One is if a franchisor could ask its franchisees to sign no-poaching agreements without turning them into a part of the franchisor’s company. The second is whether what is good for employers, such as a no-poaching agreement in this case, is not good for employees, because such agreements make it difficult for them to earn higher wages. “Here’s an example of policy being used to do something which might be great for the employer, but it’s bad for the employees.”

The Business Case for No-poaching Pacts:

Johnson explored “the economic case” for such agreements. “Many employers argue that these types of restrictive agreements protect investments they make in workers like training or protect other sorts of investments [they make] to attract clients that workers might build a relationship with and take with them,” he said. “The economic argument behind that is that if employers know that [they] can train a worker and that worker can just immediately go leave, [they] might have less incentive to provide that training. If [they] make the worker sign one of these agreements, maybe [their] incentives to provide that training goes up, and everyone’s more productive.”

On the other side of that business case is the cost to the worker in terms of fewer employment opportunities and weaker bargaining power, Johnson said. “[In order] to satisfy an economic case here, we should see that if workers sign these agreements they have some sort of demonstrable wage premium to compensate them for the costs.” However, in the fast food industry, many are paid minimum wage, without any wage variation, “suggesting that these [agreements] are not being used [with an] economic rationale,” he added. He said it is “especially pernicious” that no-poaching agreements are invisible to workers and they have “no ability to argue or negotiate over them.”

Starr referenced a paper by Alan B. Krueger and Orley Ashenfelter published in September 2017 as the first big effort to research the practice of no-poaching agreements. They found that such agreements “are included in a surprising 58% of major franchisors’ contracts, including McDonald’s, Burger King, Jiffy Lube and H&R Block.” They found the practice prevalent in industries that have relatively high worker turnover, he noted. The no-poaching agreements may not always be about protecting investments in training, but more to retain workers for longer and prevent the costs associated with worker turnover. “If they just blatantly try to restrict the movement of workers, we should be really leery of them,” he said.

The Costs of Non-compete Agreements:

Starr said the evidence is conflicting on the cost impact of non-compete agreements. “If you look at people who signed non-compete agreements versus those who don’t, it looks like those who sign them actually earn a little bit more money,” he said. That may be the case because such workers are not low-wage workers but managerial or technology workers, he explained. At the same time, his research showed a wage gain of up to 10% for workers who are notified about non-compete agreements when they get the job offer, and not on the day they start the job.

“[In order] to satisfy an economic case here, we should see that if workers sign these agreements, they have some sort of demonstrable wage premium to compensate them for the costs.” –Matthew Johnson

However, Johnson said new research he and his colleagues are working on shows that “in states where non-compete agreements are more enforceable, the typical worker’s wage goes down.” That difference in wages could be about 5%, he added.

“Maybe at the worker level you see wage gains from signing non-compete agreements, but at the economy-wide level, you see wages go down when these agreements are allowed,” said Johnson.

Alternatives to Non-poaching Agreements:

According to Starr, “If [non-poaching agreements] are good ways to protect investments in training, then we need to think a little more carefully about other ways where you could protect [them] without having these invisible constraints to the employee.” He pointed to “training repayment contracts” that are commonly used, where employees are required to pay a portion of the training costs if they leave, with a decreasing scale of payment obligations based on length of time in the position. “That’s a contract that would protect training investments but it wouldn’t necessarily hinder the employee [from leaving], especially if after a few years all of those payments are down to zero.”

Getting employees to sign non-compete agreements may not be the best way out for franchisees, Johnson suggested. He noted that “a non-compete agreement might be buried several pages into a hiring contract,” and employees may not read those long contracts and might just skim over the agreement. He said it might make sense to require employers to be upfront about restrictive covenants in their hiring contracts with workers, in order to make sure that workers are aware of them.

Starr said a big debate is underway these days on “wage transparency,” where, for example, a job applicant may want to know how much the previous person in that job was paid. “There are a lot of questions around if we were more transparent about wages, what would the effects be,” he said. “That discussion is important, but it ignores the fact that there are many non-wage characteristics for which we’re totally not transparent” such as no-poaching agreements. He noted that in many cases, new hires get to know about intellectual property assignment contracts and non-disclosure agreements on the day they join. It might be too late for them to decline those, especially when they may have turned down other job offers. “The fact that these characteristics are not transparent may be just as important as wage transparency.”

Broader Issues for Public Policy:

“There are lots of reasons why it might make sense for an employer to do things which are not good for employees,” said Cappelli. “Let’s face it – employers would like to pay as little as possible. That’s part of the business of a capitalist society. If they train people, they would like to do it as cheaply as possible and not lose the training costs. [On the other hand], employees would like to be paid as much as possible and to be able to move whenever they want. The job of public policy is to try to balance these.” He noted that non-poaching agreements are unlikely to survive legal challenges. “Non-poaching agreements are, in terms of public policy, one of the hardest ones to swallow.”

Cappelli said the latest case on non-poaching agreements in the fast food industry raises broader questions of governance. “There’s a broader question about how much effort you should be making to squeeze the wages of your employees,” he added. “There is a resurgence of the view that companies have responsibilities not just to shareholders but also to the communities around them, and to the employees around them as well. And there are lots of things that employers could do that are perfectly legal that would put more pressure on employees and would keep wages even further down. To what extent should they do that? Where is that over the bar, and where is it not?”

“There is a resurgence of the view that companies have responsibilities not just to shareholders but also to the communities around them, and to the employees around them as well.” –Peter Cappelli

The choices employees have are also pertinent to this discussion, especially when it involves issues like access to transportation and proximity, according to Cappelli. “If you’re a young kid working in the inner city or someplace and you don’t have transportation, and there’s a McDonald’s or another franchise chain near you and they offer you a job, even if you know that there’s a non-compete agreement or a non-poaching agreement, is it really going to matter to you?” he said. “You just don’t have choices. That’s part of the broader question about fairness and governance of these corporations.”

Starr noted that a fast food restaurant worker might want to switch jobs because the new job offers a promotion or other factors. “Maybe it’s because it’s closer to home, maybe because they like the boss or their friends work there or it’s a better work environment. Not all of this is going to be reflected in wages per se. There could be what economists would call ‘compensating differentials’ – other amenities about the workplace that are going to give them satisfaction outside of the wage.”

Uneven Legal Terrain:

According to Starr, the enforcement is lax of non-compete agreements: His surveys show these agreements are still being used in states that have banned them, such as California. He noted that close to half the companies in California say they use non-compete agreements with all or some of their workers. “Even if you ban these types of provisions, I’m not sure that that’s going to actually reduce their use. It could be that it’s the way that you ban them – you need to have some more teeth on it.”

Cappelli explained why companies continue to resort to non-compete agreements when they might be on weak legal ground. “The reason companies use these even when they can’t be enforced is that the employees don’t know they can’t be enforced,” he said.

Added Starr: “Basically their beliefs are that it’s going to be enforced on average regardless of which state they live in. It is a default belief that it’s a contract; it’s got your name on it, and that appears to encourage them actually to turn down job offers they might have otherwise considered.”