Firm Location and the Creation and Utilization of Human Capital

Abstract

This paper presents a theory of location choice that draws on insights from the incomplete contracts and investment flexibility (real option) literatures. Our analysis indicates that the choice of locating within rather than away from industry clusters is influenced by the extent to which training costs are borne by firms versus employees. In addition, the uncertainty about future productivity shocks and the ability of firms to modify the scale of their operations also influence location choice. In particular, we show that locating in clusters is preferred when training costs are borne by workers and when firm-specific productivity shocks can potentially be large. However, there is an incentive for firms to choose isolated locations when significant training costs are borne by firms.