Relational Contracts When The Agents Productivity Inside The Relationship Is Correlated With Outside Opportunities

An agent can choose to bear personal costs to the principal's benefit. In return, the principal offers rewards. If this exchange is not contractible, typically repeated interaction will be required to sustain it. The novel feature of the analysis is that the agent's productivity inside the relationship is correlated with productivity outside. The paper derives the implications of this arguably realistic assumption for the feasibility of relational contracts and for agent selection by principals. Applications of this framework to labor, management, and politics help organize some stylized facts.