Training the Doubtful and Timid∗

We analyze the effect of human capital on insurance within the firm. In our model human capital creates rents that are split between workers and firms. These rents are lost when employment at a particular firm is terminated, and thus create a (limited) commitment device over which a long-term contract can be agreed upon. We characterize the optimal long-term contract and study the impact that changes in human capital have on the risk-sharing between the worker and the firm. When the firm’s commitment is not binding, human capital does not affect insurance within the firm as long as the firm does not face financing costs. A worker in our model faces wage risk not because of changes in her productivity, but due to industry-wide shocks. This feature allows us to generate empirical predictions linking industry characteristics to the characteristics of the long-term contract. ∗This version of the paper is work-in-progress. †Palacios is Assistant Professor of Finance at the Owen Graduate School of Management, Vanderbilt University. Email: [email protected]. Stomper is Professor of Finance at Humboldt University, Germany. Email: [email protected].