Working Paper No. 03-02:
Privacy and Firms

Author(s):

Bruce Kobayashi, Larry Ribstein

Date Posted: 2003

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Abstract:

Privacy raises particularly difficult and important questions in the employment context. Employees and employers have competing interests in disclosing and preventing disclosure of information. Maximizing the value of a firm often requires that confidential business information be widely disseminated within the firm, but not disclosed outside the firm. At the same time, excessive protection of the employers' information could reduce employees' mobility and the flow of valuable information in society. Employers, in turn, need information about employees in order to evaluate them for hiring and to monitor them while they are employed. But employees also may have an interest in keeping some information private to protect their personal space or to hide shirking or other bad acts that are detrimental to the firm. Appropriately balancing employers', employees' and society's interests in workplace privacy contributes to social wealth by encouraging efficient employment relationships. This requires sensitivity to the unique characteristics of the economic activity that gives rise to the specific organizational form chosen by a given firm.

In some cases, the optimal solution to this problem can involve employment contracts that allow intrusions into an employee's privacy, and restrictions on an employee's freedom, including restrictions that extend beyond the employees tenure at the firm. To be sure, employees may prefer ex post not to be bound by restrictions on employment or disclosure and not to be monitored by the employer. But employees are better off ex ante to the extent that they share in the value of efficient arrangements through higher compensation. On the other hand, contractual restrictions on the dissemination of employer information or on employee mobility may benefit both employees and employers but reduce social wealth because of their negative effects on development of intellectual property and competition. However, regulation of these contracts may impose more costs than benefits. For example, restricting protection of employer information can inhibit firms from disseminating confidential business information to employees and, in turn, force revision of relationships with employees. Protecting the privacy of employees' information can inhibit monitoring of employees and force employers to resort to non-agency-type relationships.

This paper is both normative and positive. It shows why contracts regarding these issues should be enforced. It also shows that the contracts are enforced despite seemingly mandatory state rules preventing enforcement. The key to understanding the positive analysis is to see the enforcement issue in the interstate context, where both employers and employees are free to choose the states in which they live, contract, and sue.