How and when should companies retain their human capital? Contracts, incentives and human resource implications

Abstract

The increasing competition in the labor market for human capital pushes firms to create better incentives to manage talented individuals. In this article, we model the optimal employment contract when two features of human capital are present: (i) private information of the employee about his skills; and (ii) the inability to contract on the output of the employment activity. Our model shows how firms can use delegation (i.e., the employee's job autonomy) to provide the incentives to a privately informed employee. The model novelty resides in turning a classic source of potential inefficiency like asymmetric information into a factor that firms can use to design incentives. Our model provides a new explanation of why, in technologically dynamic environments, one observes more intense formations of start-ups and a greater inter-firm mobility of human capital. Our setting also suggests how established companies can use their complementary assets to provide better incentives to their skilled employees.