Restrictive Covenants and the Hazards of Transaction Cost Analysis

Abstract

A substantial literature within law and economics debates the merits of restrictive covenants from an efficiency perspective. A core theme of this literature is that the central task for legal rules is to mediate competing incentives for "opportunism" by both firm and employee. This focus on the concept of opportunism to explain parties' behavior and assist in the design of legal rules is not unique to the literature on post-employment competition. It has become commonplace for scholars analyzing organizational structures, as well as contracts more generally, to adopt the rhetoric and framework of the Williamsonian "transaction cost" model. No doubt, this approach identifies an authentic problem that firms and workers face in making innovation and training investment decisions. In spite of its popularity, I argue that the concept of opportunism is also plagued by significant indeterminacies that can limit its utility as a legal policy device in the context of restrictive covenant law. From a practical standpoint, a legal standard truly sensitive to problems of bilateral opportunism might well require empirical judgments so difficult that the standard would be essentially non-administrable. A promising alternative is to statutorily prohibit restrictive covenants, with limited exceptions that include enforcement of discrete, short-term training agreements.