Hold-up and the inefficiency of job assignments

This paper examines the trade-off between job assignments and incentives for specific investments. Under an incomplete contract, employees tend to underinvest in firm-specific human capital. To defuse this hold-up problem, the employer chooses an inefficiently low promotion standard. This result provides an explanation of the Peter Principle. However, if human capital investments also have an impact on promotion, the optimal standard might be inefficiently high.