Discretionary Acquisition of Firm-Specific Human Capital under Non-verifiable Performance

Abstract

AbstractIn this paper we develop a model of discretionary employee investment in firm-specific human capital. When a firm has full bargaining power, the non-contractibility of this investment completely undermines the employee’s incentives. However, the incumbent firm’s inability to observe competing wage offers at the interim stage prevents it from completely expropriating the surplus, thereby creating incentives for the employee to invest. We demonstrate that commitment to a wage floor for the second period destroys the worker’s incentives to acquire human capital, but makes turnover efficient. Therefore, such a commitment has value only if the return on the employee’s deliberate investment in human capital acquisition is sufficiently low. When firms are privately informed about the productivity of their human capital acquisition technology, more productive firms offer higher entry wages to separate themselves from less productive firms. Furthermore, in contrast to the case of symmetric information about human capital acquisition technology, the commitment opportunity now has value for firms with higher return on investment: commitment to a wage floor acts as a substitute for raising the entry wage.