Firm Specific Human Capital Investment in an Agency Relationship

Abstract

This paper considers the twofold problem of compensation contracting and the design of a human capital investment scheme. Before contracting the principal and the agent can engage in a joint stochastic production process of exerting effort to raise the agent’s productivity in the firm. The principal can employ synchronous effort exertion or either actor can assume a leadership role. We determine which organizational design is best for the principal at the endogenously optimal compensation contract, depending on how the efforts interact. We also determine when it is optimal for the principal to subsidize the agent to improve profitability.

Keywords: Firm Specific Human Capital, Investment Design, Agency

JEL Classification: L20, L21, L22, L23