Relational Retention

We study a repeated game model of an employment relationship in which the worker's outside option is endogenously determined by the strategic behavior of a second employer who also values the worker's services. We show that long-term employment relationships are much more difficult to sustain when outside options are endogenous rather than exogenous. In particular, they can never be sustained by a sequence of spot contracts but must instead be based on an implicit long-term agreement, a so-called relational retention contract. At the same time, relational retention contracts can support long-term employment relationships even when the worker could work in another job where he is more productive. These results provide a novel justification for the existence of rents to continued employment that rests solely on the strategic interaction between competing employers. Further, we show that tighter employment protection reduces parties' abilities to sustain long-term employment relationships and may thereby reduce overall welfare