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 oneemployee, compete on the labor market with free labor mobility. Afterobserving the investment decisions by firm owners their employees canengage in costly training, thus increasing their general and firm-specificproductivity, which also depends on capital endowment. The trustproblem is mutual since firm owners, when investing, do not know em-ployees' willingness to engage in training, while employees must hopethat future wage offers will reward training. The experimental resultsshow that higher firm-specificity of human capital makes employeesmore willing to engage in training, while low specificity triggers over-investment by firm owners. Firm loyalty is found to be usually low.