Non-Competes, Career Concerns, and Debt Covenants

Abstract

We study the impact of managers’ career concerns from non-competes enforcement on the design of debt covenants in private debt agreements. Using exogenous changes in the enforceability of managers’ non-compete clauses over the period of 1992-2004 across states in the United States, we show that borrowers headquartered in U.S. states with strong enforcement of non-compete clauses have fewer debt covenants compared to those headquartered in states with weak enforcement after controlling for reporting quality, risk taking, and firm performance. Our evidence is consistent with the argument that reduced job mobility and enhanced career concerns incentivize managers to ex ante avoid debt covenants that may trigger default and lead to high risk of terminating their current employment. Moreover, the effect of the enforceability of noncompetes on debt covenants is more pronounced for managers with limited outside options (i.e., low ability, small network) or firms with strong bargaining power with lenders.