2005): “On-the-Job Training, Limited Commitment, and Firing Costs,” working paper

We develop a model of optimal dynamic labor contracts in which \u85rms provide training to workers, but workers cannot credibly commit to stay with the \u85rm. The training is in the form of skills which can pro\u85tably be used in other job matches. In the model, wage rates rise with seniority and separation rates are higher for low skilled workers than for high skilled workers. These observations are consistent with the evidence. We show that \u85ring costs (i) increase the average duration of employer-worker matches, (ii) reduce the outside value of the worker, and (iii) increase the level of training provided by the \u85rm. This mechanism has the opposite e¤ect on measured productivity than the selection mechanism of search models with endogenous separation, where \u85ring costs reduce the average quality of active matches. Our model provides a rationale for the positive relationship observed between the level of employment protection and TFP across European countries. yPreliminary and incomplete. We would like to thank Vincenzo Quadrini, Ricardo Lagos, Andrés Erosa, an