Learning-by-employing: the value of commitment under uncertainty
We analyze commitment to employment in an environment in which an infinitely lived firm faces a sequence of finitely lived workers who differ in their ability to produce output. The ability of a worker is initially unknown to both the worker and the firm, and a worker's effort affects the information on ability that is conveyed by performance. We characterize equilibria and show that they display commitment to employment only when effort has a persistent but delayed impact on output. In this case, by providing insurance against early termination, commitment encourages workers to exert effort, thus improving the firm's ability to identify their talent. We argue that the incentive value of commitment to retention helps explain the use of fixed probationary appointments in environments in which there exists uncertainty about ability.
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