The Impact of Local Knowledge on Banking

Covenants not to compete were found in these court cases as early as 1971. While state laws did not change dramatically over time, our data reveals that the use of covenants not to compete was increasingly used by banks in the intervening years. We also checked beyond the end of our sample period and such covenants continue to be widely used and apparently are even more common now than in the past.

Interestingly, states that did not report any bank employee non-compete cases were disproportionally likely to be states that permitted only very narrow non-competes or banned them altogether. For example, a search of California cases, which has one of the highest number of banks in a single state, returned zero non-compete cases involving bank or lending employees. Furthermore, the seven states with the weakest (least willing to restrict competition) non-compete laws returned only a single court case among them, and that single case targeted a narrow exception to a general prohibition to non-competes in that state.

Since the number of court cases may simply be related to the number of banks operating in a state, we further studied the court cases by controlling for the number of banks in each state. All things being equal, we expect more court cases within states with more banks. For our control, we collected the total number of banks in operation in each state in the year 2000. In the three states with the lowest enforcement ranking, California, North Dakota, and Oklahoma, the number of banks were 304, 110 and 286, respectively. The number of banks for the three states with the strongest enforcement, Florida, Missouri, and Tennessee, were 265, 362, and 197, respectively. Although the number of banks in operation was roughly the same for the two different groups, we found six court cases in the strong enforcement states and zero in weak enforcement states. These analyses support our hypothesis that the relative strength of non-compete law in each state influences the prevalence of non-compete agreements in that state.

Of the approximately 12,000 banks in our sample in 1994, the last year in our study and the year in which bank regulation was the least restrictive during our studied period, fewer than 200 operated in more than one state.

For example, one question asks who has the burden of proving the unreasonableness or reasonableness of a covenant not to compete. If the state places the burden of proof on the employee rather than the employer, we assigned one point to that state. See Table 5.

For the rest of the paper we suppress the time and state subscripts for all of the variables. Except for the robustness tests in part 4.5, the IB and CNC variables are lagged one period. All other variables are contemporaneous.

For example, Jayaratne and Strahan (1996) performed various robustness tests excluding those states.