Working Paper: NBER ID: w15933
Authors: James E. Rauch; Joel Watson
Abstract: Client relationships create value, which employees may try to wrest from their employers by setting up their own firms. If when an employer and worker establish a relationship they cannot contract on the output and profits of the worker's prospective new firm, the employer counters by inducing the worker to sign a contract that prohibits him from competing or soliciting the current client in the event of termination of employment. The socially optimal level of entrepreneurship will nevertheless be achieved if clients, employers, and workers can renegotiate these restrictive employment contracts and make compensating transfers. If workers cannot finance transfers to employers, however, employers and workers will sign contracts that are too restrictive and produce too little entrepreneurship, and governments can increase welfare by limiting enforcement of these contracts. With or without liquidity constraints, locations where non-compete contracts are less enforced will attract more clients and have higher employment and output.
Keywords: entrepreneurship; employment contracts; non-compete agreements; client relationships
JEL Codes: K12; L26; R10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Restrictive contracts (L14) | Reduced entrepreneurship (L26) |
| Non-enforcement of contracts (K12) | Increased entrepreneurship (L26) |
| Inability to finance transfers (Z23) | Restrictive contracts (L14) |