Specific Human Capital Investment and Turnover Under Uncertainty

An equilibrium model of labor contracts under asymmetric information is developed. A profit-maximizing firm offers a wage but retains the right to lay off the worker based on its private observation of the worker's productivity ex post. The worker invests in specific human capital, unobservable to the firm, to improve the retention probability. It is shown that, under not very restrictive conditions, productivity uncertainty has adverse effects on the firm's wage offer to the worker, the worker's investment in firm-specific human capital, employment stability, and average productivity. A comparison between American and Japanese firms is made to explore the implication of the finding.