Firm-Specific Human Capital as a Shared Investment: Comment

Abstract

Employment relationships typically involve the division of surplus. Surplus can be the result of a good match, a monopoly rent, or a quasirent that arises because of a specific investment. The division of this surplus is of economic interest as it is a determinant of turnover, investment, and wages. Gary S. Becker (1962) argued, in the context of specific human-capital investments, that the incumbent employee and firm will share the surplus. This notion was formalized in a prototypical model of surplus sharing as first proposed by Masanori Hashimoto (1981). The model has been studied extensively, among others by H. Lorne Carmichael (1983), Robert E. Hall and Edward P. Lazear (1984), and Donald O. Parsons (1986), while Elizabeth Becker and Cotton M. Lindsay (1994) provide an empirical application. The key feature of the model is the existence of transaction costs. Both the employee and the firm have (ex ante uncertain) private information on which they cannot write a contingent contract. This makes that they write a nonrenegotiable contract that specifies a fixed wage. After this, the firm learns the value of the employee’s marginal product whereas the employee learns the value of his outside option. Both parties then decide unilaterally whether to separate or not and inefficient separations may occur. The wage is set in such a way as to maximize the expected total surplus. The present analysis will consider the role of uncertainty in this model. This has not been done before in a rigorous way. Hashimoto considered only degenerate cases. His analysis suggests that the wage will be low when the uncertainty of the market conditions is small, and high when the uncertainty of the conditions inside the firm is small. Parsons (1986) makes a claim that this is actually the case without deriving the result. This paper shows that the comparative statics are ambiguous and may well be the opposite of those suggested by Hashimoto and claimed by Parsons. It also provides the intuition that is behind this result, namely that uncertainty not only influences turnover but also the option value of the match and its opportunity cost. Section I, briefly summarizes Hashimoto’s model and shows that without further assumptions the comparative statics are ambiguous. Section II derives an explicit solution of the wage. Section III briefly considers alternative wage-setting schemes and Section IV concludes.