Relational Contracts and Specific Training

Nov 2014 | 732

Authors: James Malcomson

This paper explores the implications of specific training for relational contracts.  A standard result for sustaining a relational contract is that the parties must jointly receive a surplus over what they can get by separating.  This has been interpreted as employees with relational contracts having discretely higher pay and productivity than inherently equally productive, or near equally productive employees without relational contracts.  Investment in specific training relaxes the incentive constraints on relational contracts, so the optimal level of investment can be higher for those with a relational contract than for those without, adding further to the productivity of those employed under a relational contract.  But the additional cost of optimal investment precisely offsets the post-investment surplus for marginal employees in relational contracts, which removes the discontinuity in the joint payoff from a relational contract.  An example shows that with optimal investment there may not even be a discontinuity in productivity between those employed with a relational contract and those employed without one because the incentive constraints on the former result in lower effort despite their higher training.

JEL Codes: C73, D82, D86

Keywords: relational incentive contracts, investment, specific training, dual labour market

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