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Pareto-improving firing costs?

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  • Karabay, Bilgehan
  • McLaren, John

Abstract

We examine self-enforcing contracts between risk-averse workers and risk-neutral firms (the ‘invisible handshake’) in a labor market with search frictions. Employers promise as much wage-smoothing as they can, consistent with incentive conditions that ensure they will not renege during low-profitability times. Equilibrium is inefficient if these incentive constraints bind, with risky wages for workers and a risk premium that employers must pay. Mandatory firing costs can help, by making it easier for employers to promise credibly not to cut wages in low-profitability periods. We show that firing costs are more likely to be Pareto-improving if they are not severance payments.

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Bibliographic Info

Article provided by Elsevier in its journal European Economic Review.

Volume (Year): 55 (2011)
Issue (Month): 8 ()
Pages: 1083-1093

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Handle: RePEc:eee:eecrev:v:55:y:2011:i:8:p:1083-1093

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Web page: http://www.elsevier.com/locate/eer

Related research

Keywords: Implicit contracts; Invisible handshake; Firing costs;

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Cited by:
  1. Lommerud, Kjell Erik & Straume, Odd Rune & Vagstad, Steinar, 2012. "Employment protection and unemployment benefits: on technology adoption and job creation in a matching model," Working Papers in Economics 18/12, University of Bergen, Department of Economics.

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