'The Fragile Promise: Job Security and Contract Design Under Partial Commitment'

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Abstract:

We develop a dynamic contracting framework to study how partial commitment power affects long term employment relationships. In a continuous time moral hazard model, the principal can alter the contract at random, exogenously timed "alteration opportunities," with their arrival rate measuring her (lack of) commitment power. Our results depend on the relative observability of diligence and misconduct. For guardian jobs, where misconduct is easier to observe, it is optimal to offer a static, permanent contract that pays fixed performance bonuses for observed diligence and remains immune to reductions in commitment power. For entrepreneurial jobs, where diligence is easier to observe, the optimal structure features an initial probation period, a promotion bonus upon achieving permanence, and a return to probation at each alteration opportunity. In this case, weaker commitment can, under certain conditions, improve welfare; if commitment power is already low, further reductions may yield Pareto improvements. Reduced commitment power also raises required promotion and performance bonuses, shortens probation, and accelerates the decline in promotion bonuses over time.

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