Should You Allow Your Agent to Become Your Competitor? On Non-Compete Agreements in Employment Contracts
We discuss a principal-agent model in which the principal has the opportunity to include a non-compete agreement in the employment contract. We show that if the agent faces limited liability and there is an incentive problem the principal prefers not to impose such a clause if and only if the principal's profits from entering the market are sufficiently large relative to the agent's outside option. If the principal can impose a fine on the agent for leaving the firm, she will never prefer a non-compete agreement.
We discuss a principal-agent model in which the principal has the opportunity to include a non-compete agreement in the employment contract. We show that not imposing such an agreement can be beneficial for the principal as the possibility to leave the firm generates implicit incentives for the agent. The principal prefers to impose such a clause if and only if the value created is sufficiently small relative to the agent’s outside option. If the principal can use an option contract for retaining the agent, she will never prefer a strict non-compete agreement.
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