Firm Specific Investments Based on Trust and Hiring Competition: A Theoretical and Experimental Study of Firm Loyalty

Two firms, each consisting of a team with the owner and just one employee, compete on the labor market with free labor mobility. After observing the investment decisions by firm owners their employees can engage in costly training, thus increasing their general and firm-specific productivity, which also depends on capital endowment. The trust problem is mutual since firm owners, when investing, do not know employees' willingness to engage in training, while employees must hope that future wage offers will reward training. The experimental results show that higher firm-specificity of human capital makes employees more willing to engage in training, while low specificity triggers over-investment by firm owners. Firm loyalty is found to be usually low.