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Employment as a Relational Obligation to Work

This paper compares employment with spot trade of labor, formalizing arguments by Coase, Simon, and Williamson. With spot trade, an entrepreneur and a wealth-constrained worker bargain over different actions, and without agreement there is no trade. Employment is a relational contract that gives the entrepreneur the authority to choose the worker's actions. Because of incomplete information about benefits and costs, either spot trade or employment may lead to inefficient outcomes. I derive a wide range of results about the entrepreneur's optimal choice between employment and spot trade. Employment is more efficient than spot trade the greater is the quasi-rent between the parties. Additionally, employment enables the entrepreneur to minimize the worker's rent. On the other hand, a wage premium is required to ensure the worker's obedience. My results suggest that the worker's obligation to provide his service is essential to the nature of employment. By contrast, whether the worker has multiple tasks, or the entrepreneur has an information advantage, or the entrepreneur owns important assets, all matter much less than the literature has suggested. The model also provides a simple theory of the firm that captures key ideas of transaction-cost economics.