Outside options and worker motivation∗

We study the relationship between outside options and workers’ incentives to exert effort. We first set up a relational contracting model where effort is constrained by the future value of an employment relationship. To test the predictions from this model, we evaluate changes in outside options arising from age and experience cutoffs in the Austrian unemployment insurance (UI) system. Results indicate that a 9-week UI benefit extension increases worker absenteeism at the intensive margin by 0.5 days per half-year, on average. Consistent with our model predicting that these effort reductions are more pronounced if the perceived relationship value is small, we find that our effects are stronger for workers with higher potential cost of unemployment, for older workers, in declining rather than in growing firms, in low-wage firms, and for women as well as workers with children. JEL Classification: D21, D22, J22, J53, M52