Long-term work contracts versus sequential spot markets:: experimental evidence on firm-specific investment

The length of work contracts may be irrelevant for firm-specific investment if rational behavior generates endogenous job security. In an experiment, we implement such a situation and study actual investment behavior. In contrast to the game-theoretic prediction, we find reduced investment in case of short-term contracting compared to long-term contracting. This is due to nonequilibrium behavior that generates a substantial risk of unemployment if contracts are short-term. Since the effect of nonequilibrium behavior differs between institutions, the length of contract is in fact relevant for firm-specific investment. (C) 2003 Elsevier Science B.V. All rights reserved.