Give Me Equity or Give Me Death - the Role of Competition and Compensation in Silicon Valley

In this essay, I outline the hypothesis that the preeminence of Silicon Valley as an incubator of technology is attributable to equity compensation. Ronald Gilson, relying on the work of AnnaLee Saxenian, and others who have noted the tendency of Silicon Valley employees to job hop, has suggested that California law prohibiting the enforcement of non-compete agreements was a major factor in the rise of Silicon Valley (and the demise of Route 128). I extend this line of thought here by suggesting that California employers may have relied on equity compensation as a close substitute to bind employees. I argue further that equity compensation (in its many forms) is a superior way to assure the loyalty of employees for several reasons. First, equity compensation induces employees to focus on how their efforts will contribute to the success of the business. Second, equity compensation saves cash for the startup firm and permits firms to compete for talent without offering more cash. Third, equity compensation forces the company to seek and plan for liquidity. Fourth, equity compensation induces employees to consider the prospects of the employer firm and thus induces employer firms to consider the ideas of employees. In addition, equity compensation may induce employees to exit unpromising ventures sooner rather than later thus allocating resources more efficiently. Fifth, equity compensation induces firms to maintain an efficient size. If a firm grows too large, diversified, or unfocused, equity compensation will become less attractive for individual employees. Thus, equity compensation will tend to induce spin-offs and other divisive transactions in larger firms. Finally, equity compensation may be an efficient substitute for more intrusive forms of dispute Richard A. Booth is the Marbury Research Professor of Law at the University of Maryland School of Law. 1 Entrepreneurial Bus. L.J. 265 2006 266 ENTREPRENEURIAL BUSINESS LA W [Vol. 1:2