​Using novel indirect employment data and a Supreme Court ruling against subcontracted employment, this paper shows that contingent employment of skilled labor reduces innovation. Innovation increases after establishments convert subcontracted workers into direct hires compared to the establishments that did not use subcontracted workers before the ruling. The finding is without a simultaneous increase in operating leverage, R&D, and capital intensity and conditional on compensation schemes that reward employees for their investment in rm-specific skills and long-term performance. New hires do not innovate more. New inventors, including former subcontracted workers, create more and better patents, yet only through collaboration with existing inventors, who also create more and better non-collaborative patents. Furthermore, a positive spillover follows that innovation-associated voluntary employee departure increases.

JEL classication: J41, J46, L26, O31

Keywords: contingent workforce, innovation incentive, human capital, entrepreneurship