Abstract

For over three centuries, Anglo-American courts have assessed employee noncompete agreements under a Rule of Reason. Despite long-standing precedent, some now advocate banning all such agreements. These advocates contend that employers use superior bargaining power to impose such "contracts of adhesion," preventing employees from selling their labor to the highest bidder and reducing wages. Abolitionists also contend that such agreements cannot produce cognizable benefits and that employers could achieve any benefits via less restrictive alternatives without limiting employee autonomy.

This Article critiques the Abolitionist position. Arguments for banning noncompete agreements echo hostile critiques of other nonstandard contracts during antitrust law's "inhospitality era." These critiques induced courts and agencies to condemn various nonstandard agreements. Employee noncompete agreements escaped condemnation because they were governed by state contract law.

The Article recounts how Transaction Cost Economics ("TCE") undermined these critiques. TCE demonstrated that nonstandard agreements, such as exclusive territories, could overcome market failures by preventing dealers from free riding on each other's promotional efforts. TCE also concluded that such agreements were usually forms of voluntary integration, unrelated to market power. These scientific developments induced courts to abandon their hostility to nonstandard contracts, and nearly all such agreements now withstand Rule of Reason scrutiny.

TCE also undermines the case against employee noncompete agreements. Most notably, TCE predicts that most such agreements are voluntary methods of ensuring that employers capture the benefits of investing in employee training and trade secrets by deterring rival firms from free riding on such investments and bidding away employees. Application of TCE also rebuts claims that less restrictive alternatives will achieve the same objectives as noncompete agreements.

Finally, TCE undermines contentions that employee noncompete agreements injure employees by preventing them from receiving lucrative bids from competing employers. This account of harm treats hypothesized bids and resulting imagined (higher) wages as an exogenous baseline against which to measure the impact of such agreements. According to TCE, however, such bids are not exogenous. Instead, such bids often occur because noncompete agreements incentivize employers to make investments that increase employee productivity. Banning such agreements will thus reduce employee productivity, eliminating the incentive for rivals to bid for employees. In such cases, claims that noncompete agreements reduce wages invoke an illusory baseline of bids that would not occur but for the enforcement of such agreements.

Empirical evidence confirms TCE's predictions. Many such agreements apparently arise in unconcentrated markets. Most are disclosed in advance, and robust enforcement induces additional employee training. Finally, employees who receive preemployment notice of such provisions earn higher wages than similarly situated employees not bound by such agreements. Thus, many such agreements appear to be voluntary means of protecting investments in employee training, improving employee productivity, and increasing gross domestic product ("GDP").

This is not to say that all employee noncompete agreements produce significant benefits. Some employers decline to disclose such contracts until after employees join the firm. Such agreements apparently depress wages without producing benefits. Moreover, some employee noncompete agreements could raise rivals' costs and enhance employers' market power.

Neither potential impact justifies abolition. States or the Federal Trade Commission ("FTC" or "Commission") could encourage or require pre-contractual disclosure, leaving employers and employees free to adopt provisions that increase their joint welfare. Moreover, even the inventors of raising rivals' costs theory opined that most markets are not susceptible to such a strategy. Abolitionists have made no effort to establish that employee noncompete agreements usually arise in markets where such a strategy is possible. The rare prospect that parties may employ fully disclosed agreements to pursue such a strategy does not justify abolishing all employee noncompete agreements.

Indeed, banning all such agreements may have a disparate impact on small, labor-intensive firms by discouraging optimal investments in employee training. This potential impact may help explain labor union support for abolishing such agreements. Unionized firms predictably adopt capital-intensive production processes in response to collective bargaining and resulting noncompetitive wages. Laws that disadvantage nonunion, labor-intensive firms will enhance the demand for the output of unionized firms, increasing the demand for unionized labor. Banning noncompete agreements will thus sometimes boost unionized workers at the expense of their nonunion counterparts.

Document Type

Article

Publication Date

2022

Publication Information

57 Wake Forest Law Review 631-709 (2022)

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