<PAGE>

                                                                    EXHIBIT 10.2



                               December 10, 1999


Mr. Matthew K. Schatzman
3902 Amherst Street
Houston, TX   77005

Dear Matt:

         Set forth below are the terms of your employment (the "Agreement")
with Dynegy Inc. (hereinafter referred to collectively as "Dynegy" or the
"Company").

1.  TITLE AND DUTIES

         Your title shall be Division President, Energy Trading. You shall have
such duties as may be delegated from time to time by your immediate supervisor.
You will be employed at Dynegy's headquarters in Houston, Texas.  You shall
devote your full time, energy and skill to the performance of your duties for
Dynegy, and will exercise due diligence and reasonable care in the performance
of such duties.

2.  TERM

         (a)  Unless earlier terminated as provided for herein, the term of this
Agreement will be for five (5) years, beginning on the Effective Date and ending
on the fifth anniversary of the Effective Date (such period, as extended
pursuant to the next succeeding sentence, if applicable, the "Term"). The Term
shall automatically be extended for additional one (1) year periods unless
either the Company or you provides written notice sixty (60) days prior to the
date on which this Agreement would otherwise be automatically extended that such
party is electing not to so extend the Term. The term "Effective Date" means the
date of closing of the proposed merger of Dynegy Inc. and Illinova Corporation
pursuant to that certain merger agreement dated as of June 14, 1999, as amended.

         (b)  If your employment with Dynegy is terminated due to your voluntary
resignation or by the Company for "cause", this Agreement shall terminate
immediately (except for the confidentiality, non-competition and non-
solicitation provisions of Paragraph 4 and the provisions of Paragraphs 5 and
6), and the Company shall have no further obligation to you except for the
payment of amounts due before the date of such termination. You further agree
that the benefits which you have received from the execution of this Agreement
through the date of such termination constitute sufficient consideration for
your obligations pursuant to Paragraph 4, notwithstanding the fact that the
Company has no further obligation to you except for the payment of amounts due
before the date of such termination.
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Matthew K. Schatzman
December 10, 1999
Page 2

         For purposes of this Agreement, you may be terminated for "cause" as a
result of (i) your refusal to implement or adhere to lawful policies or lawful
directives of the Board of Directors of Dynegy (the "Board of Directors") or
your immediate supervisor; (ii) serious misconduct, dishonesty or disloyalty,
directly related to the performance of duties for the Company or gross
negligence in the performance of your duties for the Company; (iii) your being
convicted (or entering into a plea bargain admitting or not contesting criminal
guilt) in any felony criminal proceeding; (iv) drug or alcohol abuse; (v)
continued failure to perform your duties under this Agreement which is not cured
within 10 days after written notice of such failure is provided to you by
Dynegy; or (vi) any other material breach of this Agreement by you that is not
cured within ten (10) days after written notice of such breach is delivered to
you from the Company.

         (c) If your employment is terminated during the Term of this Agreement
due to resignation following "constructive termination" (as defined below) or
for any other reason other than your voluntary resignation, death, disability,
or discharge for cause, you shall receive as your sole compensation in lieu of
further payments to you pursuant to Paragraph 3 hereof (i) a lump sum amount
equal to the product of (x) 2.99 and (y) the greater of (a) the average annual
Base Salary and incentive compensation, whether payable in cash or stock
options, you were paid by the Company for the highest three (3) calendar years
preceding the calendar year in which your employment is terminated (or such
shorter period as you have actually been employed by the Company), or (b) your
Base Salary and target bonus amount for the year in which your employment is
terminated; (ii) a lump sum amount equal to the present value, as determined by
the Board of Directors in its sole and absolute discretion, of the benefits to
be provided to you in Paragraph 3(e) of this Agreement and such other
perquisites (if any) being provided to you on the date of your termination, as
if you were still employed for the remainder of the Term of this Agreement, with
regard to those benefits to be provided to you during the Term of this
Agreement, and as if you had completed the Term of this Agreement with regard to
those benefits to be provided to you upon completion of the Term of this
Agreement; (iii) any employee stock options granted to you prior to or during
the Term of this Agreement shall become vested as of the date of resignation due
to such constructive termination or discharge not for cause, and you shall have
the right to exercise any such vested options through the end of the Term of
this Agreement or one year from the date of termination, whichever is later; and
(iv) for a period of thirty-six (36) months from the date of resignation due to
such constructive discharge or discharge due not for cause, all health and
welfare benefits the Company was maintaining for you and your family as of the
date of such resignation or discharge.

         For purposes of this Agreement a "constructive termination" shall be
deemed to have occurred in the event that (i) your Base Salary as defined in
Paragraph 3(a), bonus compensation under Paragraph 3(b), target range of annual
option grants under Paragraph 3(c) or other compensation as described in
Paragraph 3(e) is reduced; (ii) a significant diminution in your
responsibilities, authority or scope of duties is effected, and such diminution
is made without your written consent (without regard to whether or not any
change is made to your title); (iii) the Company materially breaches this
Agreement or (iv) the relocation of the Company's principal executive offices to
a location, or the Company requires you to be based, outside a fifty (50) mile
radius from the city limits of Houston, Texas. Any resignation by you as a
result of
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 3

assertion of a constructive termination shall be communicated by delivery to the
Board of Directors of the Company within thirty (30) days from the commencement
of such constructive termination by written notice setting forth the grounds
therefor, during which period the Company shall be entitled to cure or remedy
the matters set forth in such notice to your reasonable satisfaction.

         Unless you withdraw such notice prior to the expiration of such thirty
(30) day period, such resignation shall take effect upon the expiration of
thirty days from the date of the delivery of such notice. Any other resignation
by you shall be communicated by thirty days' advance written notice.

         If you die, or become disabled and cannot perform your duties, your
employment hereunder shall be terminated and: (i) you (or your estate) shall be
entitled to the Base Salary (as defined in Paragraph 3(a)) payable to you
hereunder for twelve (12) months following the month in which you die or become
disabled, plus the amount of any target bonus as described in Paragraph 3(b) for
the year of death or disability, prorated for the period of twelve (12) months
following the date of death or disability; (ii) you (or your estate) shall
receive, for a period of twenty-four (24) months from the date of your death or
disability, all health insurance and health benefits that the Company was
maintaining for you and/or your estate and for your family as of the date of
your death or disability; and (iii) any employee stock options granted to you
during the Term of this Agreement shall become vested as of the date of your
death or disability.  For purposes of this Agreement, you shall be disabled as
of the first date on which you become eligible to receive disability benefits
under the Company's long-term disability plan (or Social Security disability
benefits at a time when the Company does not maintain a long-term disability
plan or such plan is not available to you).

         (d) Unless otherwise specified herein, all payments under this
Agreement shall be paid in a lump sum, less applicable withholding taxes, within
thirty (30) days following your termination.

3.  COMPENSATION

         (a) Each year during the Term hereof, you will be paid a base salary of
$400,000 per annum ("Base Salary"), payable in accordance with the Company's
payroll guidelines.

         Increases may be made to your Base Salary at the discretion of the
Board of Directors based upon your individual performance.

         (b) You shall be a participant in the Company's Incentive Compensation
Plan. As part of Dynegy's incentive compensation program, you will have the
opportunity to earn a target bonus in an amount equal to 100% of your Base
Salary and a maximum cash award in an amount equal to 200% of your Base Salary,
dependent upon certain financial or performance objectives, determined in
accordance with such program, and by the Board. To the extent any incentive
compensation in excess of the maximum cash amount referenced above is payable
under the Incentive Compensation Plan in any year to you, the Company will pay
you any such
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 4

amounts in noncash equivalents (e.g., stock options or restricted securities of
the Company) of equal value, as determined by the Board of Directors in its sole
and absolute discretion. At your election, in lieu of paying you all or part of
such incentive compensation bonus, the Company will allow you to direct that all
or part of such incentive compensation shall be allocated by the Company to, or
expended directly for, charitable contributions of your selection.

         (c) Upon the closing of the proposed merger of Dynegy and Illinova
Corporation pursuant to that certain merger agreement dated as of June 14, 1999,
as amended, (the "Dynegy/Illinova merger"), you will receive (x) stock option
grants pursuant to the Company's Long-Term Incentive Plan ("LTIP") with a value
equal to 150% of your Base Salary and (y) discounted stock option grants under
the Employee Equity Option Plan ("EEOP"; and, together with LTIP, the "Stock
Option Plans") with an in-the-money value equal to $500,000. The aforementioned
options will vest in accordance with the vesting provisions of each of the stock
option plans. Each year during the Term of this Agreement, you will be eligible
to receive stock option grants in accordance with the requirements and
provisions of the Company's LTIP. The current target range for annual option
grants for your position is a median of 150% and a 75th percentile of 225% of
your Base Salary. You recognize that any value of an award of "market" options
under the LTIP is a projected value, which is subject to the future performance
of the Company stock, and that there is no guarantee that the actual value of
such options will achieve that value. "Projected Value" means that at the end of
the five years from the date of grant, assuming an increase in market price of
15% per annum during the five years, the stock option may be exercised to obtain
the stated value in excess of the exercise price. These options are subject to
the vesting, forfeiture and other terms and conditions of the respective Stock
Option Plan, except as specifically provided to the contrary in this Agreement.

         (d) Upon the due execution and delivery of this Agreement by the
parties hereto, any EEOP or other options granted to you prior to November 1,
1999 shall become vested as of the date of closing of the Dynegy/Illinova
merger.

         (e) You will be entitled to participate in Dynegy's benefits programs
for senior management executives, including, without limitation, Dynegy's
deferred compensation plan for executives. In addition, the Company may provide
other perquisites as approved by the Dynegy Board of Directors, in its sole
discretion. Pursuant to the terms of Dynegy's vacation policy you will be
entitled to four (4) weeks per year of paid vacation.

4.  CONFIDENTIALITY/NONCOMPETE/NONSOLICITATION

         You recognize and acknowledge that:

         (a) You will have access to certain information concerning the Company
that is confidential and proprietary and constitutes valuable and unique
property of the Company. You agree that you will not at any time, either during
or after your employment, disclose to others, use, copy or permit to be copied,
except pursuant to your duties on behalf of the Company or its successors,
assigns or nominees, any secret or confidential information of the Company
(whether or not developed by you) without the prior written consent of the Board
of Directors of the Company. The term "secret or confidential information of the
Company"
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 5

(sometimes referred to herein as "Confidential Information") shall include,
without limitation, the Company's plans, strategies, potential acquisitions,
costs, prices, systems for buying, selling, and/or trading natural gas, natural
gas liquids, crude oil, coal, and electricity, client lists, pricing policies,
financial information, the names of and pertinent information regarding
suppliers, computer programs, policy or procedure manuals, training and
recruiting procedures, accounting procedures, the status and content of the
Company's contracts with its suppliers or clients, or servicing methods and
techniques at any time used, developed, or investigated by the Company, before
or during your tenure of employment to the extent any of the foregoing are (i)
not generally available to the public and (ii) maintained as confidential by the
Company. You further agree to maintain in confidence any confidential
information of third parties received as a result of your employment and duties
with the Company.

         (b) At the termination of your employment you will deliver to the
Company, as determined appropriate by the Company, all correspondence,
memoranda, notes, records, client lists, computer systems, programs, or other
documents and all copies thereof made, composed or received by you, solely or
jointly with others, and which are in your possession, custody, or control at
such date and which are related in any manner to the past, present, or
anticipated business of the Company.

         (c) To protect and safeguard the Company's trade secrets and
Confidential Information and also the Company's goodwill with its suppliers and
clients, for that period of time following the termination of your employment
for any reason other than pursuant to Paragraph 2(c) above (e.g. in the event of
a termination pursuant to the first paragraph of Paragraph 2(c), the non-compete
obligations imposed by this Paragraph 4(c) terminate) through the expiration of
the Term or twenty-four (24) months from the date of termination, whichever is
earlier, you will not, within a 50 mile radius of any location where the Company
had an office at any time during the Term hereof or any location where a client
or supplier of the Company (which is a material client or supplier at any time
during the Term hereof) had an office at any time during the Term hereof,
without the prior written consent of the Board of Directors of the Company,
directly or indirectly, engage in or be interested in (as owner, partner,
shareholder, employee, director, agent, consultant or otherwise), any business
which is a competitor of the Company, as hereinafter defined. For purposes of
this Agreement, a "competitor of the Company" is any entity, including without
limitation a corporation, sole proprietorship, partnership, joint venture,
syndicate, trust or any other form of organization or a parent, subsidiary or
division of any of the foregoing, which, during such period or the immediately
preceding fiscal year of such entity, was engaged in the unregulated marketing,
gathering, transportation or processing of natural gas or derivatives of natural
gas or other hydrocarbons or electricity. For purposes of this paragraph, the
following entities shall not be deemed to be competitors of the Company: (i) a
Local Distribution Company ("LDC") to the extent that any purchases or sales by
such LDC are only for consumption on its system; (ii) a natural gas producer to
the extent that such producer sells only its own production or production of
other working interest owners in wells in which it owns an interest; (iii) a
natural gas pipeline company in the jurisdictional aspects of its business,
i.e., other than a nonjurisdictional marketing affiliate or production affiliate
(except as to such production affiliates own production as described in clause
(ii) of this Paragraph 4(c)), or (iv) an integrated regulated electric and/or
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 6


gas utility, as long as the utility does not engage in the unregulated marketing
of its generation or power trading other than that related to the generation and
power marketing allocated to its own service areas. The terms of this Paragraph
4(c) shall not apply to your present or future investments in the securities of
companies listed on a national securities exchange or traded on the over-the-
counter market to the extent such investments do not exceed one percent (1%) of
the total outstanding shares of such company.

         (d) For a period of twenty-four (24) months after the expiration or
termination of your employment for whatever reason other than pursuant to
Paragraph 2(c) above or for a period of twelve months following the termination
of your employment pursuant to Paragraph 2(c) above, you shall not solicit,
raid, entice, encourage or induce any person who at any time during the term of
this Agreement shall have been an employee of the Company, or any of its
subsidiaries or affiliated companies, to become employed by any person, firm or
corporation, and you shall not approach any such employee for such purpose or
authorize or knowingly approve the taking of such actions by any other person,
firm or corporation or assist any such person, firm or corporation in taking
such action.

         (e) You agree that the foregoing restrictions contain reasonable
limitations as to the time, geographical area, and scope of activity to be
restrained and that these restrictions do not impose any greater restraint than
is necessary to protect the goodwill and other legitimate business interests of
the Company, including but not limited to the protection of Confidential
Information. You also agree that the general public shall not be harmed by
enforcement of this Paragraph 4. Should any provision in this Paragraph 4 be
held unreasonably broad with respect to the restrictions as to time,
geographical area, or scope of activity to be restrained, any such restriction
shall be construed by limiting and reducing it to the extent necessary to render
it reasonable, and as so construed, such provision shall be enforced.

         Accordingly, you consent and agree that if you violate any of the
provisions of this Paragraph 4, the Company and its subsidiaries and affiliated
companies would sustain irreparable harm and, therefore, in addition to any
other remedies which the Company may have under this Agreement or otherwise, the
Company shall be entitled to an injunction from any court of competent
jurisdiction restraining you from committing or continuing any such violation of
this Paragraph.  You acknowledge that damages at law would not be an adequate
remedy for violation of this Paragraph 4, and you therefore agree that the
provisions of this Paragraph 4 may be specifically enforced against you in any
court of competent jurisdiction.  Nothing herein shall be construed as
prohibiting the Company from pursuing any other remedies available to the
Company for such breach or threatened breach, including the recovery of damages
from you.

5.  INDEMNIFICATION

         If, at any time during or after the Term of this Agreement, you are
made a party to, or are threatened to be made a party in, any civil, criminal or
administrative action, suit or proceeding by reason of the fact that you are or
were a director, officer, employee, or agent of the Company, or of any other
corporation or any partnership, joint venture, trust or other enterprise for
which you served as such at the request of the Company, then you shall be
indemnified by the Company, to the fullest extent permitted under applicable
law, against
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 7

expenses actually and reasonably incurred by you or imposed on you in connection
with, or resulting from, the defense of such action, suit or proceeding, or in
connection with, or resulting from, any appeal therein if you acted in good
faith and in a manner you reasonably believed to be in or not opposed to the
best interest of the Company, and, with respect to any criminal action or
proceeding, had no reasonable cause to believe your conduct was unlawful, except
with respect to matters as to which it is adjudged that you are liable to the
Company or to such other corporation, partnership, joint venture, trust or other
enterprise for gross negligence or willful misconduct in the performance of your
duties. As used herein, the term "expenses" shall include all obligations
actually and reasonably incurred by you for the payment of money, including,
without limitation, attorney's fees, judgments, awards, fines, penalties and
amounts paid in satisfaction of a judgment or in settlement of any such action,
suit or proceeding, except amounts paid to the Company or such other
corporation, partnership, joint venture, trust or other enterprise by you. The
foregoing indemnification provisions shall be in addition to any other rights to
indemnification to which you may be entitled.

6.  ARBITRATION

         The parties hereto may attempt to resolve any dispute hereunder
informally via mediation or other means. Otherwise, any controversy or claim
arising out of or relating to this Agreement, or any breach thereof, shall,
except as provided in Paragraph 4, be adjusted only by arbitration in accordance
with the rules of the American Arbitration Association, and judgment upon such
award rendered by the arbitrator may be entered in any court having jurisdiction
thereof.  The arbitration shall be held in the city of Houston, Texas, or such
other place as may be agreed upon at the time by the parties to the arbitration.
The arbitrator(s) shall, in their award, allocate between the parties the costs
of arbitration, which shall include reasonable attorneys' fees of the parties,
as well as the arbitrators' fees and expenses, in such proportions as the
arbitrator(s) deem just; provided however, notwithstanding the above, in the
event you are the prevailing party, then the Company agrees to reimburse you for
all such costs of arbitration, including, but not limited to attorneys' fees and
expenses reasonably incurred by you; provided further, notwithstanding the
above, in the event the Company is the prevailing party, then the total costs of
arbitration, including but not limited to attorneys' fees reasonably incurred by
the Company and arbitrators' fees and expenses that may be allocated to you by
the arbitrator(s) shall not in any event exceed Twenty-Five Thousand Dollars
($25,000). Notwithstanding the foregoing, you shall be entitled to seek specific
performance in a court of competent jurisdiction of your right to be paid your
full compensation until your separation from employment, during the pendency or
dispute of any controversy arising under or in connection with this Agreement.

7.  OTHER PROVISIONS

         (a) THIS AGREEMENT WILL BE GOVERNED BY, CONSTRUED AND ENFORCED IN
ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS, EXCLUDING ANY CONFLICTS OF LAW,
RULE OR PRINCIPLE THAT MIGHT OTHERWISE REFER TO THE SUBSTANTIVE LAW OF ANOTHER
JURISDICTION.

         (b) Except as otherwise indicated, this Agreement is not assignable
without the written authorization of both parties; provided that the Company
shall cause this Agreement
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 8

to be assumed by any entity to which the Company transfers substantially all of
its assets or to any entity which is a successor to the Company by
reorganization, incorporation, merger or similar business combination.

         (c) Except as otherwise provided herein, the provisions of Paragraphs
4, 5 and 6 of this Agreement shall survive the termination of this Agreement.

         (d) All payments to you under this Agreement will be subject to the
withholding of all applicable employment taxes and income taxes; provided,
however, that at your request the parties hereto will use reasonable efforts to
explore alternatives to allow the Company to make charitable contributions on
behalf of the employee by redirecting a portion of your annual bonuses to
charitable organization(s) chosen by you in accordance with Paragraph 3(b).

         (e) This Agreement supersedes all previous employment agreements,
written or oral, between the Company and you. This Agreement may be amended only
by written amendment duly executed by both parties or their legal
representatives and authorized by action of the Board. Except as otherwise
specifically provided in this Agreement, no waiver by either party hereto of any
breach by the other party hereto of any condition or provision of this Agreement
to be performed by such other party shall be deemed a waiver of a subsequent
breach of such condition or provision or a waiver of a similar or dissimilar
provision or condition at the same or at any prior or subsequent time.

         (f) Any notice or other communication required or permitted pursuant to
the terms of this Agreement shall be in writing and shall be deemed to have been
duly given when delivered or mailed by United States mail, first class, postage
prepaid and registered with return receipt requested, addressed to the intended
recipient at his or its address set forth below and, in the case of a notice or
other communication to the Company, directed to the attention of the Board of
Directors with a copy to the Secretary of the Company, or to such other address
as the intended recipient may have theretofore furnished to the sender in
writing in accordance herewith, except that until any notice of change of
address is received, notices shall be sent to the following addresses:

       IF TO YOU:                     IF TO THE COMPANY:
          Matthew K. Schatzman           Dynegy Inc.
          3902 Amherst Street            1000 Louisiana, Suite 5800
          Houston, TX   77005            Houston, TX   77002
                                         Attn:  President

         (g) If any one or more of the provisions or parts of a provision
contained in this Agreement shall for any reason be held to be invalid, illegal
or unenforceable in any respect, such invalidity or unenforceability shall not
affect any other provision or part of a provision of this Agreement, but this
Agreement shall be reformed and construed as if such invalid or illegal or
unenforceable provision or part of a provision had never been contained herein
and such
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 9

provisions or part thereof shall be reformed so that it would be valid, legal
and enforceable to the maximum extent permitted by law.

         (h) Neither you nor the Company will make or authorize any public
statement disparaging the other in its or his business interests and affairs.
Notwithstanding the foregoing, neither party shall be (i) required to make any
statement which it or he believes to be false or inaccurate, or (ii) restricted
in connection with any litigation, arbitration or similar proceeding or with
respect to its response to any legal process. The provisions in this Paragraph
7(h) shall survive the termination of your employment hereunder, irrespective of
the reason therefor.

         (i) The waiver by the Company of breach of any provision of this
Agreement by you shall not operate or be construed as a waiver of any subsequent
breach by you. The waiver by you of a breach of any provision of this Agreement
by the Company shall not operate or be construed as a waiver of any subsequent
breach by the Company.

         (j) You shall not be required to mitigate damages (or the amount of any
compensation provided under this Agreement to be paid) following your
termination of employment, by seeking employment or otherwise.

         (k) If any provision of this Agreement as applied to either party or to
any circumstances shall be adjudged by a court of competent jurisdiction to be
void or unenforceable, the same shall in no way affect any other provision of
this Agreement or the validity or enforceability of this Agreement.

         (l) The section headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement.

         (m) This Agreement may be executed in one or more counterparts, which
shall, collectively and separately, constitute one agreement.

         (n) Notwithstanding anything to the contrary set forth in this
Agreement, the Company may cause any of its subsidiaries for which you render
services to pay or otherwise satisfy, in whole or in part, some or all of the
Company's obligations hereunder.

         If the foregoing reflects your understanding of the terms of your
employment with the Company, please execute each copy of this letter in the
space provided below.

                                    DYNEGY INC.



                                    By:
                                       -----------------------------
                                    Name:  Stephen W. Bergstrom
                                    Title: President
<PAGE>

Matthew K. Schatzman
December 10, 1999
Page 10

AGREED AND ACCEPTED this
     day of December, 1999
-----

------------------------------
    Matthew K. Schatzman