No-poaching clauses in franchise agreements recently have attracted widespread attention from the press, state Attorneys General, private litigations, and Congress. The concern is that franchise no-poaching clauses may increase monopsony power by increasing the share of jobs that individual employers control. Fundamental empirical support for these investigations and legal claims is based on important assumptions and limited empirical research. This paper challenges fundamental assumptions in previous research, demonstrating that those claims of the highly concentrating effects of franchise no-poaching clauses are invalid. This paper also demonstrates the need for a new type of concentration measure for market arrangements and contractual terms like franchise no-poaching clauses that produce differences in effective concentration across suppliers within the same geographic and product market.

By Daniel Levy, TimTardiff1

 

I. INTRODUCTION

There has been significant recent interest in no-poaching clauses of franchise agreements, in the press,2 the courts,3 enforcement agencies,4 and the U.S. Congress.5 These no-poaching clauses restrict an owner of a franchise (“franchisee”) from hiring employees from another franchisee within the same brand. There is no restriction against hiring across franchise brands.

Franchise owners may have an incentive to hire experienced/ trained employees from other franchise locations, rather than train them, because the franchise restaurants are independently owned and have an incentive to maximize their own profit.6 Therefore, a potential benefit of no-poaching clauses is the increased incentive they provide employers to provide experience, training and other forms of human capital to relatively unskilled/inexperienced workers, which the employer may benefit from in later stages of an employee’s tenure. Weighing against this potential benefit are the anticompetitive effects caused by concentrating the control of jobs within the franchise brand, thereby reducing employee bargaining power.7,8

There has been little empirical research examining the effects of no-poaching clauses on workers, or even the market concentration they cause. Although Krueger and Ashenfelter’s (“K&A”) paper that focuses on the effects of no-poaching clauses within franchise agreements has not been published, it is cited by journalists,9 State Attorneys General,10 economic11 and legal publication,12 the U.S. Congress,13 and private litigants14 as the empirical support that no-poaching clauses reduce workers’ wages by significantly concentrating control of employment positions in the hands of owners of franchises. This broad reliance on K&A for actions with potentially important effects on labor and employers calls for serious economic evaluation of the working paper.

K&A did not measure the effect of no-poaching agreements directly on wages or employment, but instead used a standard Herfindahl-Hirschman Index15 (“HHI”) to measure the extent of concentration in labor markets for a subset of the fast food industry, “quick service restaurants” (“QSR”), in Rhode Island (“RI”). K&A claims that the contractual hiring restriction within brands functionally converts all franchises within a brand into a single employer: “Franchisees are not permitted to hire from each other, which is equivalent to making the group of franchisees belonging to a chain a single employer in this labor market.”16 The first part of the statement in K&A is correct; franchisees typically may not hire from within the brand under a no-poaching clause. However, the second part of that claim in K&A is incorrect; no-poaching clauses do not make all franchisees within a brand into a single employer, because an employee of a given franchise within a brand can still seek employment at every location of all other franchise brands with no-poaching clauses, even if restricted within his/her current franchise brand. K&A’s claim that the no-poaching clause makes all franchise employers within a brand into a single employer is not based on empirical findings, the theoretical models K&A cite, or the employment limitations imposed on employees of franchises with no-poaching agreements. Rather, K&A’s additional labor mobility restriction, not the actual no-poaching clauses, creates the central result in K&A that is so heavily cited, a large increase in concentration. Without this unsupported assumption, K&A’s evidence of the significant concentrative effects of no-poaching clauses in franchise agreements vanishes.17

This paper evaluates the effect of no-poaching agreements and whether there even is a relevant single measure of concentration for workers in labor markets under no-poaching clauses. This paper addresses the theoretical need for a different measure of concentration that reflects the concentration faced by various employee groups. We evaluate the underlying theoretical support in K&A that leads to their claim that no-poaching agreements cause franchisees within a brand to function as a single employer within the market. Finally, we compare the performance of our new, alternative measure of market concentration to that proposed in K&A in the same labor market K&A analyzed, QSR employees in RI. The results from the measure of concentration applicable to no-poaching agreements alter the empirical conclusions about market concentration in K&A.18

 

II. NO-POACHING CLAUSES: HOW THEY WORK AND WHOM THEY AFFECT

Franchise no-poaching clauses restrict owners of restaurants from hiring employees of other restaurants within the same franchise brand. K&A provide a number of examples of no-poaching clauses, including the following from McDonald’s:

Interference With Employment Relations of Others.

During the term of this Franchise, Franchisee shall not employ or seek to employ any person who is at the time employed by McDonald’s, any of its subsidiaries, or by any person who is at the time operating a McDonald’s restaurant or otherwise induce, directly or indirectly, such person to leave such employment. This paragraph 14 shall not be violated if such person has left the employ of any of the foregoing parties for a period in excess of six (6) months.19

The independent franchise owner is not restricted from hiring any employee except those already employed within her/his own branded franchise. Conversely, the employee can seek employment from every individual location of other franchise brands.20 Employees, of course, can also seek employment outside the franchised QSR industry.

The following three figures further illustrate the effects on employees of no-poaching clauses: (1) concentration for restaurants without no-poaching clauses, (2) actual concentration with no-poaching clauses, and (3) concentration with no-poaching clauses under K&A’s assumptions that each brand should be treated as a single employer. Figure 1 depicts a hypothetical set of restaurants without no-poaching clauses.

Each colored circle represents a group of restaurants within a franchise brand within a market.21 Each green dot is an individual restaurant. Some restaurants are not part of a branded franchise. The number proximate to each colored circle represents the number of restaurants within the franchise brand. Absent no-poaching clauses, any employee within each of these restaurants could seek employment at all restaurants. Making the simplifying assumptions of K&A, that each restaurant has the same number of employees and that the relevant market is only those restaurants and employees working within branded franchises QSRs, the standard HHI measure is 38.3 (=10,000/261), if the 261 franchised QSRs in the hypothetical example above are a separate market.

Figure 2 depicts the effect of the no-poaching clause on the employees of the restaurants within one of those branded franchises.

With a no-poaching clause, the employees at a franchise of the brand depicted in green no longer have the option to seek employment at the other 77 franchise restaurants in the green brand. However, these green brand employees may obtain work at any of the other 183 individual restaurant franchises of the other brands where they are not currently employed. In this example, the concentration in the market based on the number of alternative employers increases from HHI = 38.3 to HHI = 919.98, for the employees of the green brand.22

The employees at other franchise restaurants face a different change in concentration. Employees at the yellow franchise with 17 locations face a change in HHI from 38.3 to 40.06. The smaller number of restaurants in the yellow brand means the franchise no-poaching clause has a smaller effect on concentration of number of employers for employees there.

However, K&A view no-poaching clauses as having an additional restriction on employee mobility beyond that stated or enforced in franchise no-poaching clauses, which “make a franchise brand into single employer.” The effect of such an assumption is depicted in Figure 3, where each of the franchise brands changes from multiple restaurant employment opportunities to a single potential employer controlling multiple jobs.