The Role of Promotion in Inducing Specific Human Capital Acquisition

Workers routinely carry out activities that increase their productivity with their current employer for which they are not directly compensated. For example, a worker may be asked to develop relationships with clients or shop floor staff, or he may develop a better understanding of how his firm operates. Firmspecific human capital of this type is difficult to quantify so that it is likely to be difficult to directly compensate the worker for its acquisition. This paper is concerned with designing compensation schemes for employees to induce them to collect nonverifiable firm-specific human capital. If firms develop reputations for fairly compensating workers for skill collection, the vagueness of these skills may not provide a significant incentive problem. I consider the case where firms do not have the opportunity to develop reputations. As a result, the acquisition of human capital is subject to a dual moral hazard problem, first noted in Kahn and Huberman [1988]. First, a worker only collects skills if there is a promise of a higher wage if he does so. Second, the employer has an incentive to claim that the worker has not collected these skills even when he in fact has, in order to save on wage costs. So, on the one hand, it is difficult to repay the worker after skills are collected as the firm has an incentive to renege. However, the worker cannot be repaid before collecting skills as he has no subsequent incentive to collect them. Following the institutional literature, I assume that the firm can commit to a labor contract which attaches wages to different tasks. The principal purpose of the paper is to show that the firm can use this ability to commit to a wage scale for different tasks to induce a worker to collect firm-specific human capital in the presence of this dual moral hazard problem, where the worker is rewarded for skill acquisition by promotion to another job. Assume that a worker can be assigned to one of two jobs, D and