"Nominal labor contracts replicate net of tax real contracts contingent on aggregate risk in the model presented. Perhaps this is a model of money." (title page note)

We analyze commitment to employment in an environment in which an infinitely lived firm faces a sequence of finitely lived workers who differ in their ability to produce output. A worker’s ability is initially unknown to both the worker and the firm. A worker’s effort affects the information on ability conveyed by his performance. We characterize equilibria and show that they display commitment to employment only when effort has a persistent but delayed impact on output. In this case, by providing insurance against early termination, commitment to employment encourages workers to exert effort, thus improving the firm’s ability to identify workers’ talent. The incentive value of commitment to retention helps explain the use of probationary appointments in environments in which there is uncertainty about individual ability.