Toward a Contract Theory of Strategy: Contracting, Bargaining. and the Strategic Management of Human Capital (PRELIMINARY DRAFT)

Transcription

1 March 2011 Toward a Contract Theory of Strategy: Contracting, Bargaining and the Strategic Management of Human Capital (PRELIMINARY DRAFT) Claudio Panico, Bocconi University, Milan. claudio.panico@unibocconi.it Abstract By combining the literature on contracting and negotiating with the strategy literature on rent appropriation and on the exploitation/exploration trade o, I develop a theoretical framework to investigate the strategic management of human capital. I model the relationship between the owner of a rm and a knowledgeable individual that must be engaged in research. The key ingredients of the strategic management of human capital are embedded in a employment contract that speci es the allocation of the individual s time between research and development, and the balance between exploitative and explorative research. I focus on two frictions of the employment relationship: i) contract incompleteness, that leads to bargaining over the innovation value and generates a value appropriation concern, and ii) adverse selection due to asymmetry of information on the individual s knowledge characteristic. I posit that the owner s (the individual s) relative bargaining power is greater when research is more exploitative (explorative), and then study how to balance exploitation and exploration to motivate at best the informed individual. By studying the design of the employment contract, I show that as the rm s technological capability increases, we pass from a scenario with excessive time devoted to fully explorative research, in which the individual captures most of the innovation value, to a scenario with excessive time devoted to development, with fully exploitative research, in which the owner appropriates most of the innovation value. This is a rst step in the direction of a contract theory of strategy, with micro foundations rooted in the employment of talented individuals.

2 1 Introduction Firms rely on human and knowledge assets to generate new ideas and develop new technological capabilities, two ingredients that are crucial to competitive advantage. Vast literature investigates the link between value creation potential of human capital and rms performance, also deriving implications for theory of the rm (Grant, 1996). But human capital and knowledge, like any other advantage that a rm can have in generating a rent, does not lead automatically to higher pro ts (Peteraf and Barney, 2003). Indeed, the literature in the strategic management of human capital (SMHC) stresses that the value creation and appropriation dimension that underlie many knowledge-intensive activities must be studied simultaneously (Co 1999). Yet, there are very few attempts to theorize about the SMHC. In this paper, I develop a theoretical framework to answer to the following question: How do value creation and appropriation reverberate in the formal mechanisms that underlie the SMHC? The focus is on aspects that pertain to strategic management of innovation and to employment of knowledgeable individuals. This is a rst e ort to advance a contract theory of strategy (Reve, 1990) with micro foundations rooted in the employment of talented individuals (Teece, 2003). Building on the literature on contracting and bargaining, I set up a model in which the generation of knowledge outputs inside the rm and the allocation of innovations value is endogenously determined. The implications for the SMHC derive from studying the employment contract o ered by the manager-owner of the rm to an individual whose knowledge and time are key factors of production. By designing the contract, the owner of the rm 1

3 can specify: (i) the allocation of the individual s time between the development of existing projects and the research of new ideas; (ii) the balance between exploitative research and explorative research (March, 1991), and (iii) the pecuniary compensation. The individual s value creation potential pertains to his ability to generate innovation value: more knowledgeable individuals that work in rms endowed with better technological capabilities, and that spend more time in doing research, can generate more valuable ideas. The value appropriation concern originates because of the incompleteness of the employment contract: The contract cannot specify ex ante a performance metric for a future idea, and the owner and the individual bargain ex post over the allocation of the innovation value. Adding to this limitation to contract, the owner does not observe the individual s knowledge characteristic, and there is an adverse selection concern. The most crucial aspect of the SMHC pertains to the balance between exploitation and exploration. I argue that the explorativeness of research a ects the power distribution between the owner and the individual when they negotiate ex post, and that it can be used as an additional instrument to separate ex ante individuals with di erent knowledge characteristics. When the individual is engaged in a fully exploitative research, based on re nement of existing competencies, technologies and assets, the new ideas will need the support of the rm s complementary assets to generate value. Because he won t be able to develop his idea alone (leaving the rm), the individual will be in a weak bargaining position when negotiating with the owner, and he will capture a small share of the innovation value. Conversely, if the individual is engaged in a research that is fully explorative, that looks at 2

4 new possibilities and alternatives, the new ideas will be linked to a lower extent to the rm s assets, which implies that the individual will be in a better bargaining position and will capture a larger share of the innovation value. By the same token, when the owner balances exploitation and exploration, the resulting power distribution will be more in favor of the individual when research is more explorative. Given that a positive relationship exists between explorativeness of research and the individual s bargaining power, it must be decided how to balance exploitation and exploration, and how to allocate the individual s time between development and research. These choices should be sensitive to how knowledgeable the individual is, and the owner must design an employment contract that provides him with the right incentives to reveal his true characteristic. What are then the mechanisms that a non informed owner uses in the SMHC to balance development/research, exploitation/exploration, and how much rents are captured by the individual? Three possible scenarios are identi ed: 1. In the rst scenario, the individual is engaged in a fully exploitative research, and his bargaining power when negotiating is low. This focus on exploitation is also accompanied by an excessive focus on development, meaning that, in comparison to the ideal case in which there is complete information, the individual s time is reallocated from research toward development. 2. In a second scenario, the owner opts for the most explorative innovation activities, and the power distribution shifts in favour of the individual. To this choice corresponds a reallocation of time from development to research, so that now there is too much 3

5 research in equilibrium. 3. In a third scenario, research is intermediate between exploitation and exploration, and the allocation of time coincides with the ideal case of complete information. Moreover, while in the rst two scenarios the individual obtains an information rent, in this last case the owner can extract the full rent. It is then proved that as the rm s technological capability increases in comparison to the individual s knowledge characteristic, we pass from full exploration and excessive research (with power more concentrated in the individual s hands), to a balancing between exploitation and exploration (with an intermediate power distribution), to full exploitation and excessive development (with power more concentrated in the owner s hands). These ndings shed more light on the mechanisms that underlie the SMHC and the management of innovation, and shows that there are more nuanced links among rms technological capabilities, individuals knowledge assets and value creation and appropriation than usually studied in prior literature. 2 Background Co (1997) highlights that the management of human capital is challenging because rms compete with individuals for rent appropriation, and that oftentimes key individuals with private information command large rents. Recent research works have elaborated on bargaining and rent appropriation, both from a micro perspective, to shed light on the SMHC 4

6 in employer-employee relationships (Campbell, et al., 2010; Wang et al., 2009), and from a macro perspective, studying the bargaining process that underlies the renewal of resources and capabilities (Co, 2010; Kim and Mahoney 2010). MacDonald and Ryall ( 2004) take a wider industry perspective and study how competition can lead to value appropriation. Lippman and Rumelt (2003a,b) adapts concepts from cooperative game theory to the strategy perspective. Despite the recognition that value creation, value appropriation, and information asymmetry are interdependent, not much work has been done to investigate the implications for the SMHC. As a rst step in the direction of the micro foundations of the SMHC, I focus on the frictions that underlie employment relationships, investigating the mechanisms to be used to engage individuals with di erent characteristics in the rm s knowledge-intensive activities. The starting point of my analysis is Teece s (1986) insightful analysis of the conditions that allow a rm pro t from innovation, and of the role of assets complementarity in in- uencing the appropriability regime of inventions. My approach is also akin to Campbell et al. (2010), who, building on Teece (1986), argue that complementary assets owned by the rm in uence value appropriation and bargaining (that in turn a ect an individual s decision to leave the rm). I further argue that the relative bargaining power of the owner and the individual is endogenous, and depends ultimately on the decisions pertaining to the management of innovation. I also build on March (1991) who di erentiates between exploitative research, based on 5

7 re nement of existing competencies and technologies, and explorative research, that looks instead at new possibilities and alternatives. But my analysis of the exploitation/exploration trade-o is of a very di erent nature. March focuses on the uncertainty of returns from exploration, and on their distribution across time and (organizational) space. I look instead at how the balance between exploitation and exploration a ects the boundaries of negotiation on new ideas, and how this is linked to the provision of the incentives. In trying to formalize the SMHC within a contracting framework, I respond to Reve s (1990) comment that "contract theory of strategy needs to be more precisely developed", as well as to Teece s (2003) complaint that "there has been little e ort to sketch out implications for the nature of employment and the theory of the rm." In the theoretical framework advance herein, the main aspects of the SMHC are embedded in the employment contract that is designed to engage knowledgeable individuals. I also contribute to the recent strategy literature that analyzes how technological capabilities impact on the rms decisions to balance exploitative and explorative innovation (Zhou and Wu, 2010). As for the modelling approach, my analysis relates to the literature that studies the e ects of appropriability on the generation and use of new ideas (Anton and Yao, 1994, 1995; Aghion and Tirole, 2004; Panico, 2009), and analyzes the tension between exploitation and exploration, either with moral hazard (Hellmann and Thiele, 2011; Manso, 2011) or with adverse selection (Gambardella et al., 2010). 6

8 3 The Model I study the employment relationship between the owner of a rm and a knowledgeable individual. The rm has a certain technological capability, that is captured by a parameter > 0, and the individual is privately informed about his knowledge characteristic k. The owner must decide how to allocate the individual s available time between research of new ideas and development. I normalize to 1 the individual s available time, and let t (or 1 t) indicate the time devoted to research (or development). The owner balances exploitation and exploration by choosing r 2 [0; 1]; let r = 0 indicate a fully exploitative research, while r = 1 stands for a fully explorative research. Thus, r measures the level of explorativeness of research. The individual obtains no utility from the time devoted to development, while the owner obtains a payo that is linear and equal to (1 t). Research is instead valuable for both parties, and to the choice of r 2 [0; 1] corresponds a new idea whose innovation value is I r (). Because a ects equally development and research, the technological capability of the rm does not push the owner to allocate more time to one activity or the other. This is done to exclude straightforward considerations from the analysis, and following this reasoning, I further assume that the value of a new idea does not depend on the nature of research: (A1) I r () = I(t; k), for all r 2 [0; 1], and I(t; k) = 2 p tk. I impose this condition to isolate the incentive e ects of the exploitation/exploration trade o from any other alternative e ciency-driven explanations. For example, for given 7

9 time t and knowledge k, the owner could select the research associated with the greatest value I r (). Because I mute this e ciency e ect, the owner is only concerned by the incentive e ects of her choice. As for the speci c assumptions on the functional form, it is only needed to obtain closed-form solutions. What matter are the properties of the function I(t; k): It increases with t at a decreasing rate, increases with k (which is consistent with the interpretation of k as knowledge), and there are complementarity e ects between knowledge and time, I tk = 1 p1 2 tk > 0. 1 Value appropriation is an issue because the owner and the individual must bargain over the allocation of the innovation value of a new idea. I apply the symmetric Nash bargaining solution. To simplify, I normalize the owner s reservation utility when negotiating to zero, while the individual s reservation utility depends on how the owner decides to balance exploitation and exploration. If the owner selects a fully exploitative research, r = 0, she is protected when negotiating with the individual: Because a new idea needs the support of the rm s complementary assets to generate value, the individual s reservation utility and his ability to appropriate the innovation value is low. But to high protection corresponds low incentives. When the owner asks for a fully explorative research and r = 1, the rm s assets are less fundamental, the individual s outside option is larger and he appropriates the largest share of the innovation value. To the high incentives for the individual corresponds a low protection for the owner. To balance exploitation and exploration is tantamount to balance protection and the 1 The reader knowledgeable in contract theory will recognize the standard Spence-Mirrlees, or sorting condition. 8

10 provision of the incentives, and one of the most crucial decisions in the SMHC is how to select r 2 [0; 1]. I assume that the individual s reservation utility depends on an exogenous and an endogenous factor. The exogenous factor relates to aspects such as intellectual property rights protection, the individual s ability to raise funds to nance a new idea, the availability of additional resources in the market, etc., and it is captured by a parameter 2 [0; 1]. The endogenous element pertains to the selection of the type of research, and I assume that the individual s reservation utility corresponds to a fraction s of the innovation value, s2 p tk, where the variable s = r captures the idea that more exploration guarantees to the individual a larger reservation utility. 2 Following the discussion, when Nash-bargaining for the innovation value, the owner and the individual obtain negotiation payo s 1 2 p tk 2 s2 p tk = (1 s) p tk (1) and s2 p tk p tk s2 p tk = (1 + s) p tk, (2) respectively. 3 The individual is also o ered an up-front payment p, and the net payo s are = 1 t + (1 s) p tk p, (3) for the owner, and u = (1 + s) p tk p, (4) 2 The model can be generalized to the case of a function s(r) that is increasing in r. 3 Because s 1, the principal and the agent produce a larger innovation value when working together, so that the reservation utilities only serve as threat points that are never chosen. 9

11 for the individual. If the individual decides not to work for the owner in the rst place, he obtains a payo 1 2 k2, which captures the idea that a more knowledgeable individual has better market opportunities. The owner obtains a payo that is constant and normalized to zero. The characteristic k is the individual s private information, and from the owner s point of view k is distributed uniformly over k 2 [k; k] = K. 4 The owner designs an employment contract that is o ered to the individual and that de nes the three elements of the SMHC as a function of his announcement, k ~ 2 K: (1) the balance between exploitation and exploration, or ultimately a share s( k) ~ 2 [0; 1]; (2) the research time t( k) ~ 0; and (3) the up-front payment p( k) ~ 0. Summing up, the employment relationship unfolds along three stages. At T = 0, the owner establishes the type of research, the balancing between development and research, and the up-front payment. At T = 1, the individual can refuse the o er, or accept it and become an employee. At T = 2, the individual allocates his time as speci ed in the contract and conducts research. At T = 3, a new idea arrives, and the parties Nash-bargain for the allocation of the innovation value. The game then ends. 3.1 Benchmarks SMHC with complete information This is the benchmark in which k is observed by the owner. She maximizes her payo subject to the constraint that the individual s payo is not lower than 1 2 k2 (the so called individual 4 The model can be generalized to the case of a cdf F (k). 10

12 rationality constraint (IRC)). The owner solves the following program: max (t;p;s) 1 t + (1 s) p tk p s.t. p + (1 + s) p tk 1 2 k2, for all k, (IRC), (t; s) 2 [0; 1] 2. It is easy to check that (IRC) is binding at the optimum, so that we can substitute for p in the objective function, and that whether research is exploitative or explorative (r) is irrelevant. The optimal research time, t (k), is simply t (k) = k, (5) and at the optimum the owner s expected payo is (k) = (1 + k) 1 2 k2. (6) I assume that (k) is non-negative, meaning that in the benchmark of symmetric information the owner always hires the individual. Note that the allocation of time between development and research does not depend on and, and that a more knowledgeable individual devotes more time to research, but does not necessarily generate greater pro ts for the rm. Thus, (k) increases with k only if the technological capability of the rm,, is larger than the individual s knowledge, > k The SMHC when the information is asymmetric This is the second-best case in which the owner must design the employment contract without knowing the individual s knowledge characteristic. The di culty for the SMHC is that 11

13 the individual must be provided with adequate incentives to reveal how knowledgeable he really is. In addition to the (IRC) constraint, the owner must take the following incentive compatibility constraint (ICC) into account: q k 2 arg max ~k p( k) ~ + (1 + s( k)) ~ t( k)k ~, for all k 2 K. (7) Following standard procedure, we can de ne the individual s information rent when revealing his true characteristic as U(k) = p(k) + (1 + s(k)) p t(k)k 1 2 k2, (8) and then apply the following: Lemma 1 The employment contract must satisfy the following conditions: q 1. du(k) = (1 + s(k)) 1 t(k) k (optimality); dk 2 k 2. d(k) dk 3. ds(k) dk 0 (monotonicity for research time); 0 (monotonicity for explorativeness of research); 4. U(k) 0 (participation constraint). Lemma 1 echoes standard results in the literature in contract theory and its formal proof is omitted. 5 Point 1, 2 and 3 provide necessary and su cient conditions for (ICC). Point (1) follows by applying the envelope theorem to (8), and point (2) is a familiar monotonicity (or implementability) condition. The peculiarity of our analysis is Point (3), which is a monotonicity condition for the additional screening instrument in our analysis. When 5 But see Panico (2010). 12

14 designing the employment contract, the owner is constrained to o er more research time and a more exploration to a more knowledgeable individual. Point 4 is the participation constraint. When studying the SMHC with adverse selection, di erent scenarios may arise, according to how the interval [k; k] compares to the parameters and. Next, I discuss these scenarios informally, while the formal results brie y appear in Section 4. 4 Results and intuitions I look at three separate cases: the two extreme cases in which the owner opts for full exploitation (s = 0) or full exploration (s = 1), and the case in which she balances exploitation and exploration (s 2 (0; 1)). 4.1 Full exploitation and excessive development I start considering the case in which the owner chooses s = 0, maintaining the most favorable bargaining position. What are the incentive e ects of such strategy, and how does it a ect the balance between research and development? To answer this question, let s make the following experiment. Consider the case in which the owner o ers to the individual the same time allocation as in the rst-best, 6 and then look at whether a more knowledgeable individual obtains lower or greater information rents. By Lemma 1, when imposing s = 0 and t(k) = t (k), du(k) dk = 2 k, (9) 6 Note that this is implementable because t (k) satis es the monotonicity condition in Lemma 1. 13

15 that is always positive if k < k L = 2. (10) Assuming that (8) is satis ed, the information rents increase with k. The individual s incentive is to claim that the negotiation payo is very low and that a high up-front payment must be paid to him to ensure participation. The owner is concerned with reducing the information rents, and by Lemma 1, this is obtained by reducing t(k) to decrease the slope of U(k). The individual s time is reallocated from research to development. Given the modi cations in the allocation of time when s = 0, the second question pertains to when this choice is optimal for the SMHC. As it is shown in Proposition 2 in the next section, s = 0 is the equilibrium choice if (10) is satis ed. The rst result of my analysis is to show that if the rms technological capability is large compared to the individual s knowledge characteristic, then research is fully exploitative, s = 0, and less time (t(k)) is devoted to research. The individual obtains an information rent U(k). 4.2 Full exploration and excessive research I then consider the opposite case in which s = 1, meaning that the owner provides the largest incentives to the individual and minimizes her ability to appropriate the innovation value. To understand the incentive e ects of this strategy, note that when imposing s = 1 and t(k) = t (k), by Lemma 1 du(k) dk = 1 (1 + ) k. (11) 2 14

16 The sign of Equation (11) is always negative if k > k H = 1 (1 + ). (12) 2 If (12) holds true, then the information rents decrease with k: The individual s incentives are to claim that his payo when refusing the o er, 1 2 k2, is very high, and thus pretend that he has a high k. To reduce the information rents, the owner increases t(k) to t(k), meaning that she reallocates the individual s time from development to research. As it is shown in Proposition 3 in next section, the owner optimally sets s = 1 if (12) is satis ed. The second result is that when the individual s knowledge characteristic is large compared to the rm s technological capability, then there is a fully explorative task, and more time (t(k)) is allocated to research. The individual obtains an information rent U(k). 4.3 Balancing exploitation and exploration The third case that I analyze is in between the two cases above, and 0 < s < 1. This is a very particular case because the owner can nullify the individual s information rents. To see this, note that when the owner o ers to the individual a schedule s(k) and a time schedule t (k), by Lemma 1 du(k) dk = 1 (1 + s(k)) k, (13) 2 that can be set to zero choosing s(k) = ^s(k) = k (14) The owner can choose a payment to set the individual s utility equal to 1 2 k2. As it is shown in Proposition 1 in the next section, this scenario corresponds to the case in which 15

17 k L < k < k < k H. The third result is to show that for intermediate values of the individual s knowledge characteristic, the owner balances exploitation and exploration and chooses a time allocation that corresponds to the rst-best. The individuals obtains no information rent. In Figure 2 I represent the three intervals for the set [k; k] = K such that the owner chooses full exploitation (K 1 ), balances exploitation and exploration (K 2 ), and chooses full exploration (K 3 ), and the corresponding research time and information rents. Figure 1 about here. Next, I study the optimal SMHC corresponding to these three cases. 5 The optimal SMHC For illustrative purposes, it is easier to start considering the case in which the owner balances exploitation and exploration, s 2 (0; 1). Let ^t(k), ^s(k) and ^U(k) indicate the equilibrium values of research time, of explorativeness of research and of the information rents. Also, remember the de nition of k L and k H in (10) and (12). Proposition 1 If [k; k] [k L ; k H ] thenthe optimal SMHC entails a balancing between k 1 exploitation and exploration, with ^s(k) = 1, and no distortion in the allocation of 2 time between development and research, ^t(k) t (k). The individual obtains no information rent, ^U(k) 0. Proof. Assume that the owner o ers to the individual the rst-best time schedule, t (k). By Lemma 1, the owner can set du(k) dk 0 choosing s(k) = ^s(k) as in (14). This choice is feasible because condition [k; k] [k L ; k H ] implies that ^s(k) 2 (0; 1), and because ^s(k) 16

18 satis es the monotonicity condition in Lemma 1. After having set du(k) dk = 0, by (8) the owner can choose accordingly the up-front payment p(k) : U(k) 0. The trick here is to ne-tune the individual s negotiation payo by a ecting his reservation utility, thereby manipulating his incentives. Despite the fact that he is privately informed about his knowledge characteristic, by balancing exploitation and exploration the owner can nullify the individual s rents, without distorting the time allocation. I consider next the two cases in which the mechanism of Proposition 1 does not work, starting with the case discussed in Section 3.1. Let t(k), s(k) and U(k) indicate the new equilibrium values. Proposition 2 If k < k L then the optimal SMHC entails a fully exploitative research, s(k) = 0, for all k 2 K, and a distortion toward development, t(k) t (k), with an equality at k = k only. The individual obtains a positive information rent, U(k) 0, with an equality at k = k only. Proof. If k < k L then ^s(k) < 0, which is not feasible. The information rents are strictly increasing because du(k) = 1 (1 + s(k)) k > 0 for any possible choice of s(k). The (P C) dk 2 constraint is binding at k = k, and setting U(k) = 0, the owner can lower the individual s rents by decreasing s(k), so that at the optimum s(k) 0. Instead of o ering t (k), the owner can reduce the research time to reduce the rents. By Lemma 1, du(k) dk = 1 2 r t(k) k k, (15) and standard procedure shows that the owner maximizes the so called virtual surplus h 1 t(k) + 2 p i t(k)k " k k ( k 1 r t(k) k) 2 2 k 17 k!#, (16)

19 subject to the monotonicity condition (2) in Lemma 1. Maximizing pointwise, the optimal time schedule t(k) is t(k) = k 1 2 k k 4k( k. (17) k) 2 It is easy to check that t(k) increases with k, so that the monotonicity condition is satis ed, and we observe a downward distortion in the research time, with no distortion at k = k. Finally, consider the case of Section 3.3, letting t(k), s(k) and U(k) indicate the new equilibrium values. Proposition 3 If k > k H then the optimal SMHC entails a fully explorative research, s(k) = 1, for all k 2 K, and a distortion toward research, t(k) t (k), with an equality at k = k only. The individual obtains a positive information rent, U(k) 0, with an equality at k = k only. Proof. If k > k H then ^s(k) > 1, which is not feasible. The slope of the information rents is negative for any possible choice of s(k), so at the optimum U( k) = 0. The owner can lower the individual s information rents by increasing s(k), making the slope less negative, and at the optimum s(k) 1. Instead of o ering t (k), the owner can reduce the research time to reduce the rents. By Lemma 1, du(k) dk = r (1 + ) t(k) 2 k k, (18) and standard procedure shows that the owner maximizes the virtual surplus h 1 t(k) + 2 p " r!# i (k k) (1 + ) t(k) t(k)k + ( k k, (19) k) 2 2 k subject to the monotonicity condition (2) in Lemma 1. Maximizing pointwise, the optimal time schedule t(k) is t(k) = k 1 + (1 + )(k k) 8k( k, (20) k) 2 18

20 that satis es the monotonicity condition, and we observe an upward distortion in the research time, with no distortion at k = k. Proposition 1, 2 and 3 formalize the discussion in Section 4, highlighting how the SMHC is contingent on the rm s technological capability and the individual s knowledge characteristic. 6 Conclusions I investigate the SMHC in relation to the innovation activities inside the rm. A simple model is set up that combines value creation, value appropriation, and information asymmetries when studying the tension between development/research and exploitation/exploration. The key ingredients of the SMHC are embedded into the employment contract to be o ered to a knowledgeable individual. In an e ort to analyze the micro foundations of the SMHC, I focus on two frictions that underlie the employment relationship. First, the employment contract is incomplete and there is bargaining ex post. Second, there is an adverse selection problem because the individual holds a private information about his knowledge characteristic. I posit that a positive relationship exists between explorativeness of research and the individual s ability to capture the innovation value. The balance between exploitative and explorative research is an additional instrument that can be used to separate ex ante individuals with di erent knowledge characteristics. The analysis highlights how rm s technological capability and individual s knowledge a ect contract design. By relying on the formalism of the literature on contracting and negotiating, I develop 19

21 a framework more suited to strategy scholars. I see this as a rst step in the direction of a contract theory of strategy (Reve, 1990). Further research on the strategic management of human capital and innovation can also provide a better theoretical understanding of the nature of employment and the theory of the rm (Teece, 2003). 20

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24 k K 2 Figure 1: The three scenarios analyzed in this paper. 1 K 3 K k k t ) ( * ) ( ) ( t * k k t ) ( ) ( ˆ * k t k t ) ( ) ( t * k k t L k H k k 0 ) ( U k 0 ) ( ˆ U k 0 ) ( U k 1