Contracts and on-the-job search ☆ Roberto Bonilla Department of Economics, Newcastle University Business School, University of Newcastle upon Tyne, Newcastle upon Tyne, U.K. Received 19 July 2005; received in revised form 12 March 2007; accepted 13 March 2007 Available online 21 March 2007 Abstract The paper studies a matching model with on-the-job search, transferable utility and heterogeneous agents. Matched agents can set the conditions under which a given match can be dissolved. It is shown that matched agents use sign-off fees to extract all capital gains from trade when a third agent is contacted. In equilibrium, this redistributes wealth towards less able individuals, reduces the likelihood that any given match will be rejected and, given the conditions, it yields efficiency. Although externalities arise when a match is formed and when turnover occurs, the decentralized outcome is efficient when the production function is sub-modular and the difference in abilities is big enough. The results obtained may provide theoretical support for the type of contracts used in some markets, such as sports markets. © 2007 Elsevier B.V. All rights reserved. Keywords: Matching models; search theory; sign-off fees; on-the-job search The objective of this paper is to study the equilibrium outcome in a matching model with on- the-job search, transferable utility and ex ante heterogeneous agents. Matched agents decide the conditions under which a given match can be dissolved. As an example, consider two types of agents, hs and ls, where hs have higher ability than ls. The productivity of a match is a function of the ability of the agents involved. Because utility is transferable, both agents in a match will be interested in maximizing total match payoff. Assume an h and an l form a match (an hl match) knowing that the h can contact a single h in the future, and they decide to allow a turnover (a break-up of their own match and the formation of an hh match) if the contact occurs. It is shown in detail that they set a sign-off fee (payable to the l left single) that drives the capital gain of the hh match to zero. That is, they use a sign-off fee to extract all gains from the turnover. Under Available online at www.sciencedirect.com Labour Economics 15 (2008) 512 – 536 www.elsevier.com/locate/econbase ☆ I would like to thank the two referees, Professor Fabien Postel-Vinay and Professor Kenneth Burdett for their comments on previous drafts of this paper. E-mail address: roberto.bonilla@ncl.ac.uk. 0927-5371/$ - see front matter © 2007 Elsevier B.V. All rights reserved. doi:10.1016/j.labeco.2007.03.002