Noncompetition Clauses: Unreasonable or Efficient?

Generally, legislators and courts look upon noncompetition agreements unfavourably. This paper questions the assumptions underlying the traditional theories on noncompetition clauses and advances two theories that have previously not been found in the legal literature. It is argued that noncompetition clauses are used as a device to self-select employees who desire a long-term contract with the firm. Furthermore, employees agree to these clauses to guarantee that the employer will make specific investments in the employment relationship. The noncompetition agreement protects the creation and distribution of the surplus of the employment relationship. Legal restrictions on noncompetition clauses have the danger of decreasing the ex ante value of the employment relationship. The result will be lower investments and lower wages.