The inability of employers to monitor perfectly the level of effort of their employees is a potentially serious impediment to labor market efficacy. Indeed, a number of recent studies have concluded that this may lead to involuntary unemployment (Shapiro and Stiglitz [1984], Sparks [1986]); an inefficient sectoral allocation of workers (Oi [1990], Strand [1986]); and discrimination against productively identical workers (Bulow and Summers [1986]). This paper shows that the lock‐in effect of firm‐specific human capital can help alleviate problems of worker moral hazard and thereby promote labor market performa