A Model of Loyalty and Competence

An agent shows loyalty to his manager by bearing personal costs to the superiors benefit. In return, the manager may offer various forms of rewards. If this exchange is not contractible, typically repeated interaction will be required to sustain it. Beyond loyalty, the manager is interested in the employees competence. This analysis looks at the inevitable tradeoff between these two valued qualities when, as is to be expected, more competent agents have more attractive outside opportunities. It finds that: (1) the manager may find it optimal to hire a less competent employee so as to induce loyalty (as is frequently observed in practice), (2) even when loyalty is both feasible and net productive, it may not be optimal (i.e., the manager prefers spot contracting), and that (3) loyalty will be a signal of low competence.