Ulric B. and Evelyn L. Bray Seminar

Theoretically and empirically, we find that firms consider potential employees using a real options approach, as they do when making other types of capital investment decisions. Firms value probationary employment arrangements that provide the option to learn about the productivity of workers before permanent investment occurs. Higher uncertainty and adjustment costs hinder permanent investment and increase the value of this option. Greater competition for workers speeds up investment, increasing the value of probationary employment. Higher worker redeployability leads to more investment if firms face sufficiently low competition. Novel data from the labor market from MBA graduates confirms these implications.