The Impact of Outsourcing on Investments in Firm-Specific Human Capital under Varying Contract Regimes

Abstract

Investments in firm-specific human capital have come to play a central role in the value creation for most companies and organisations as job tasks have become ever more complex and demanding to carry out. Today successful performance of essential job tasks often necessitates highly specialised knowledge and skills, thus requiring continuous updating of employee competences. This paper develops a two-period agency model to show how the threat of layoff (outsourcing of job tasks to a third party supplier) can help a company trigger or ease employee investments in firm-specific human capital by creating explicit career concerns for the individual employee. Results are provided under long-term as well as short-term contracting regimes. In particular, the paper has relevance for companies operating under short-term contracting where investments in firm-specific human capital might be profitable yet very difficult or even impossible to induce.