Choosing between Up-or-Out and Spot Contracts: Human Capital Investment versus Job-Matching Considerations

Up-or-out contracts can improve human capital investment incentives but lead to suboptimal worker-employer separation. When job matching uncertainty is large relative to the return to human capital investment, spot contracts Pareto dominate up-or-out contracts. Otherwise, up-or-out contracts are more efficient. This view seems consistent with contractual choices in many different situations including those for university appointments with different emphases on research and teaching. The model also shows that human capital investment can be positively correlated with turnover under the up-or-out contract, a prediction different from that of the traditional human capital theory but consistent with casual observations of university professors' experiences. The result shows that the relationship between human capital investment and labor turnover should be understood in the context of a chosen contractual form.