Abstract: 

We study agency contracts where a project owner (principal) privately learns her opportunity cost of continuing the relationship after the agent’s effort is sunk. The principal controls the design of termination rights and faces a trade-off between preserving incentives and retaining exit flexibility. Even without legal constraints, fully flexible (at-will), fully rigid (lock-in), and intermediate contracts offering partial security and compensation can all arise at equilibrium. While some contracts may appear to protect the agent, they are always socially inefficient, justifying targeted legal constraints on termination rights. In particular, at-will contracts always under-secure the agent and under-enforce the project and can be banned on efficiency grounds. Inefficiencies also include excessive termination payments and over-securing, suggesting both too much and too little flexibility distort outcomes. Finally, we characterize a minimal mandatory termination fee, as commonly seen in employment protection laws, that partially restores efficiency.