Anti-Poaching Agreements in Labor Markets Oz Shy

Rune Stenbacka

Seminar Presentation Liverpool Business School Liverpool, Sept 29, 2017

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Introduction

Background and motivation

Background and motivation Employees are the most important asset of a firm. Typically very costly for employers (firms) if experienced productive workers switch to rivals. R&D intensive firms compete aggressively to recruit experienced high-skilled workers. Examples: software engineers, biotechnology, chip designers. Commonly-used recruitment method: Attractive “poaching” offers to workers employed by competitors. Higher salary to induce a worker to switch employers. Firms may have an incentive to form an anti-poaching agreement (commonly referred to as a “no cold call” agreement).

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Introduction

A Silicon Valley Court case

A Silicon Valley Court case In 2010, the US DOJ’s Antitrust Division filed a complaint against Adobe, Apple, Google, Intel, Intuit, and Pixar. The charge: Bilateral anti-poaching agreements violate Section 1 of the Sherman Act. The argument: Anti-poaching agreements are anti-competitive as they eliminate a significant form of competition to attract high-tech employees, thereby making employees worse off. Subsequent litigation: The antitrust action was followed by a 2013 civil class action, involving 64,446 class members. Settlement: On 9/2/2015, District Court in San Jose approved a $415 million settlement ($5,770 avg. per worker).

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Introduction

Other cases

Other past and recent cases Anti-enticement laws in Southern US states during 1875-1930 imposed financial fines on planters trying to poach workers with an existing employment contract. Naidu (2010) empirically found that these laws reduced competition and reduced labor mobility. In 1946, Henry Ford II hired many executives from GM after losing a significant market share to GM (more innovative firm). Ciapanna (Rand J., (2011)) analyzes client firms that poach consultants from their consulting company. At AOL Time Warner, 12 out of 19 in the strategy group were hired from McKinsey, Bain, and BCG. American Express hired > 50 from McKinsey in 1 year. WSJ May 31, 2015: Carnegie Mellon University is scrambling to recover after Uber poached 40 of its researchers and scientists, a raid that left a world’s top robotics research institutions in a crisis. Sept. 9, 2016, a former LG sales manager sues LG and Samsung (Northern Calif. Fed. Court) for agreeing not to poach each other’s US employees (LG denied such an agreement ever existed). O. Shy, R. Stenbacka

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Introduction

DOJ and FTC antitrust guidance

DOJ and FTC antitrust guidance for human resource professionals October 2016: Naked wage fixing and anti-poaching agreements are per se illegal. ”If the agreement is separate from or not reasonably necessary to a larger legitimate collaboration between employers, it is deemed illegal without any inquiry into its competitive effects”. A per se illegal status seems to require, as a robust feature, that anti-poaching agreements damage market performance. Otherwise, a rule of reason approach would appear to make sense. A rule of reason approach seems consistent with established practice applied to certain other types of agreements, for example RJVs. Our study: What are the pros and cons of a per se illegality policy?

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Introduction

Research questions

Anti-poaching agreements: Research questions

What are the effects of anti-poaching agreements on profits, worker surplus, and total welfare? What are the main effects of competition for productive workers in the absence of anti-poaching agreements? Note: An anti-poaching agreement is not a mechanism for the coordination of wage setting, because workers always have the option to switch employers if they find it beneficial.

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Introduction

Modeling labor markets

Modeling imperfect competition in labor markets Labor market theory relies heavily on perfect competition (supply & demand curves, firms take market wage as given). Alan Manning (Monopsony in Motion, 2000): 1. Employers are wage setters (not wage takers, as in perfect competition). 2. A wage cut of 1c/ does not cause all workers to leave an employment relationship (as implied by perfect competition). 3. There are important frictions in labor markets (such as heterogeneous preferences, costs of labor mobility). 4. Labor economics should adopt a similar approach to that in industrial organization, and start the analysis from the position that employers have some market power in the labor market.

We apply the imperfect competition approach: heterogeneous switching costs for workers switching and wage-setting firms that can adopt poaching offers in order to implement wage discrimination. O. Shy, R. Stenbacka

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Introduction

Modeling method

Modeling method

Duopoly labor market with firms competing for workers. Costly for workers to switch employers. Differentiated switching costs. The productivity of a worker may increase or decrease as a result of a switch to a new employer. “Poaching offers” in labor markets resemble “history-based” pricing in the product markets [examples: Chen (1997), Fudenberg and Tirole (2000), Gehrig, Shy, and Stenbacka (2010), Esteves (2010), and surveys in Villas-Boas (2007) and Esteves (2009)].

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Introduction

Main Results

Main Results Labor market competition in the absence of anti-poaching agreements 1. Firms pay higher wages to workers who switch from a competing firm. Sliwka and Kampk¨otter (2014): evidence from the German banking industry. 2. In equilibrium, some workers always switch employers [even if switching reduces the productivity of a switching worker]. 3. History-based (employment-based) wage discrimination reduces the intensity of labor market competition. [Opposite result of history-based price discrimination in the product market]. 4. Higher and more differentiated worker switching costs soften labor market competition. [Same result as history-based price discrimination in the product market]

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Introduction

Main Results (con’d)

Main Results (con’d)

5. Aggregate industry profit increases under anti-poaching agreements (but, one firm may lose under certain conditions). 6. Workers are unambiguously worse off under anti-poaching agreements. 7. Hence, the effects for total welfare of an anti-poaching agreement always reflect a tradeoff between industry profit and worker surplus. 8. With sufficiently strong productivity-enhancing switching, anti-poaching agreements always reduce total welfare. 9. With moderately productivity-enhancing switching combined with high switching costs or with productivity-reducing switching, anti-poaching agreements improve total welfare.

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The model

The labor market

The model: The labor market

Two firms (employers) labeled A and B. wA and wB are wages paid to “loyal” employees. vA and vB are wages paid to “poached” employees. Under an anti-poaching agreement, wA = vA and wB = vB . 2n workers: Initially, n are employed by A and n by B.

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The model

Workers and productivity

The model: Workers and productivity A worker produces k units of output in the present employment relationship. A worker produces k 0 units of output when switching to a rival firm. Definition: We say that switching between employers is (a) productivity-enhancing if it increases the worker’s productivity (k 0 > k); (b) productivity-reducing if it decreases the worker’s productivity (k 0 < k); (c) productivity-neutral if the worker’s productivity does not change (k 0 = k).

k 0 − k measures the magnitude of productivity change associated with switching.

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The model

Labor mobility and switching costs

The model: Labor mobility and switching costs Workers differ in their cost of switching employers Cost of switching is σs, where σ > 0 and s ∈ [0, 1] [worker-specific] The utility function of a worker s who initially works for firm i is defined by ( wi if continues to work for firm i Ui (s) = vj − σs switches to work for firm j, Workers with high switching costs (high s) stay loyal Workers with low switching costs (low s) switch employers 0

n si workers who switch to from i to j

Switching thresholds are: sA = O. Shy, R. Stenbacka

vB − wA σ

Anti-Poaching Agreements

si stay loyal to i

and sB =

-s

1

vA − wB σ

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The model

Cost, output, and profits

The model: Cost, output, and profits Cost (total wage bill) of firm i: ci (wi , wj , vi , vj ) =

n(1 − si )wi | {z }

+

loyal workers’ wages

nsj vi |{z}

poached workers’ wages

Output of firm i: qi (wi , wj , vi , vj ) = n(1 − si )k + | {z } loyal workers

nsj k 0 | {z }

workers switching from j

Firm i chooses loyalty and poaching wages to maximize expected profit: max πi (wi , wj , vi , vj ) = pqi − ci , wi ,vi

where p (output price) is exogenously given. O. Shy, R. Stenbacka

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Equilibrium with poaching

Wage analysis

Poaching equilibrium: Analysis of equilibrium wages

wA = wB =

p(2k + k 0 ) − 2σ 3

and vA = vB =

p(k + 2k 0 ) − σ . 3

(a) All wages decline with switching costs: wi ↓, vi ↓ when σ ↑ (b) There is a wage premium for switching workers: vA > wA and vB > wB (premium increases with switching cost parameter, σ). (c) All wages increase with output price and the productivity parameters: wi ↑, vi ↑ when p ↑, k ↑, k 0 ↑.

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Equilibrium with poaching

Labor mobility and switching

Poaching equilibrium: Labor mobility and switching

The fraction of switching workers: sA = sB = 0

n si workers who switch from i to j

1 3

+

p(k 0 −k) 3σ

si stay loyal to i

-s

1

si ≥ 1/3 ⇐⇒ k 0 ≥ k (switching enhances productivity) si = 1/3 if k 0 = k (switching has no effect on workers’ productivity) Some workers switch employers even when switching is unproductive (k 0 < k)

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Equilibrium with poaching

Equilibrium profits

Equilibrium profits Industry profit: Π = πA + πB =

2n  [p(k 0 − k) − σ]2 + p 2 (k 0 − k)2 + 4σ 2 . 9σ

Equilibrium industry profit increases with the switching cost parameter (σ). Industry profit increases with the output price (p). Industry profit increases with the productivity change induced by switching (k 0 − k) if and only if σ ≤ 2p(k 0 − k). Note: If the last condition is reversed, poaching competition becomes too costly for firms.

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Equilibrium with poaching

Worker surplus and total welfare: Definitions

Worker surplus (WS) and total welfare (W): Definitions Total labor income equals firms’ total wage cost: I = cA + cB . Worker surplus equals total income (wages) minus switching costs: WS = I − SC , where 0

n si workers who switch from i to j Z SC = n

sA

Z σs ds + n

0

sB

σs ds = 0

si stay loyal to i

-s

1

n [p(k 0 − k) + σ]2 , 9σ

Total welfare equals worker surplus plus industry profit: W = WS + Π, where Π = πA + πB

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Equilibrium with poaching

Profits, worker surplus, total welfare: Graphs

Profits, worker surplus, total welfare: Graphs

Total welfare: W = Π + WS

← more (labor competition) less →

W Π WS

σ max

σ min

σ

Worker surplus and total welfare decrease when switching becomes more costly. Profits increase (relaxed competition). O. Shy, R. Stenbacka

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Anti-poaching agreements

Anti-poaching agreements: Wages

Anti-poaching agreements: Wages Definition: Competing firms (employers) form an anti-poaching agreement if they agree not to apply poaching wages in order to attract workers from the rivals. Formally, firms are restricted to setting uniform wages, denoted by uA = wA = vA and uB = wB = vB . Workers have no incentives to switch employers with identical wages (uA = uB ) , hence we analyze an asymmetric equilibrium where uA ≥ uB . Workers switch only from B to A, so that the fractions of switching 0 workers sAAP = 0 and sBAP = p(k3σ−k) , for k 0 ≥ k. Note: ‘Interesting’ equilibrium because symmetric firms end up in an asymmetric equilibrium!

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Anti-poaching agreements

Anti-poaching agreements: Wages

Effects of anti-poaching agreements on wages Suppose k 0 > k. Then, an anti-poaching agreement reduces the wages paid to all types of workers. Formally, (uAAP < wA < vA and uBAP < wB < vB ); reduces labor mobility not only by eliminating switching from the high-wage firm as sAAP = 0, but also by reducing switching in the other direction as sBAP = sB − 13 . Therefore, an anti-poaching agreement weakens wage competition in the labor market. Note: If k 0 = k, firms pay identical wages uAAP = uBAP = pk − σ and there is no switching.

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Anti-poaching agreements

Anti-poaching agreements: Profits

Effects of anti-poaching agreements on profits

Industry profit

Suppose k 0 ≥ k. Then, an anti-poaching agreement increases the profit of the high-wage firm. The high-wage firm attracts some workers to switch from the rival firm and it earns a higher profit than the competing firm. Formally, πAAP − πBAP = np(k 0 − k)/3 ≥ 0; the profit of the high-wage firm relative to the poaching equilibrium. Formally, πAAP ≥ πA ; the profit of the low-wage firm relative to the poaching equilibrium if and only if workers face sufficiently high switching costs. ← more (labor competition) less → Formally, πBAP ≥ πB if and only if √
def σ ≥ σBAP = 1 + 2 p(k 0 − k)/2. Π aggregate industry profit relative Π to the poaching equilibrium. =⇒ Formally, ΠAP > Π. AP

σ max

σ min

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Anti-poaching agreements

Anti-poaching agreements: Worker surplus

Effects of anti-poaching agreements on worker surplus Aggregate worker surplus is lower under the anti-poaching agreement compared with the poaching equilibrium. Formally, WS AP < WS.

Worker surplus

← more (labor competition) less →

WS AP WS

σ max

σ min O. Shy, R. Stenbacka

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σ

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Anti-poaching agreements

Anti-poaching agreements: Total welfare

Effects of anti-poaching agreements on total welfare √

Define:

26 def 2 + 2 + z = √ 26 2+ 2 −

2 3 1 3

√ >1

and

AP

σW

def =

2+

26

2

!

0

p(k − k).

(a) If k 0 > zk, an anti-poaching agreement always reduces total welfare compared with the poaching equilibrium. (b) If k ≤ k 0 < zk, an anti-poaching agreement increases total welfare AP . compared with the poaching equilibrium if and only if σ ≥ σW ← more (labor competition) less →

W AP W

σ min O. Shy, R. Stenbacka

W AP W

Total welfare (k 0 < zk)

Total welfare (k 0 > zk)

← more (labor competition) less →

σ max

σ

σ min

Anti-Poaching Agreements

AP σW

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Conclusions

Conclusions: Summary of results Endogenous variable

Effects of anti-poaching agreements

Fraction of switching workers (si )

Reduced

Aggregate worker surplus (WS)

Reduced

Aggregate industry profit (Π)

Enhanced (small firm may lose) Reduced if (k 0 > zk)

Total welfare (W )

AP ) or (k ≤ k 0 < zk and σ < σW

Enhanced if (k ≤ k 0 < zk AP ) or (k 0 < k) and σ > σW

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Conclusions

Potential Extensions

(a) Separating the expected magnitude from the dispersion of the switching costs. [Characterization in the appendix] (b) Labor force heterogeneous not only with respect to switching costs, both also w.r.t. productivity. (c) Interaction between strategic competition in both the labor and product markets. [Anti-poaching agreements may have different effects on industry profit and welfare in the presence of strategic product market considerations.]

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Conclusions

Conclusions

(a) Access to industry-specific facts are needed in order to verify whether an anti-poaching agreement could prevent firms from engaging in excessively aggressive recruitment of human capital from rivals. (b) Even though one should not exaggerate the number of industries where anti-poaching agreements could be beneficial, our analysis justifies a policy whereby anti-poaching agreements should be judged on a case by case basis, giving firms an option to present an efficiency defense. [In line with the intuitive comment made by Heyer and Shapiro (2010).]

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