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Termination of dynamic contracts in an equilibrium labor market model

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  • Wang, Cheng
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    Abstract

    In an equilibrium model of the labor market, workers and firms enter into dynamic contracts that can potentially last forever, but are subject to optimal terminations. Upon termination, the firm hires a new worker, and the worker who is terminated receives a termination contract from the firm and is then free to go back to the labor market to seek new employment opportunities and enter into new dynamic contracts. The model permits only two types of equilibrium terminations that resemble, respectively, the two kinds of labor market separations that are typically observed in practice: involuntary layoffs and voluntary retirements. The model allows for the simultaneous determination of a large set of important labor market variables including equilibrium unemployment and labor force participation. An algorithm is formulated for computing the model's equilibria. I then simulate the model to show quantitatively that the model is consistent with a set of important stylized facts of the labor market.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Economic Theory.

    Volume (Year): 146 (2011)
    Issue (Month): 1 (January)
    Pages: 74-110

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    Handle: RePEc:eee:jetheo:v:146:y:2011:i:1:p:74-110

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    Web page: http://www.elsevier.com/locate/inca/622869

    Related research

    Keywords: Dynamic contract Equilibrium termination Labor market;

    References

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    1. Smith, Anthony Jr. & Wang, Cheng, 2006. "Dynamic credit relationships in general equilibrium," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 847-877, May.
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    4. Stephen Spear & Cheng Wang, . "When to Fire a CEO: Optimal Termination in Dynamic Contracts," GSIA Working Papers 2002-E5, Carnegie Mellon University, Tepper School of Business.
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    8. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
    9. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Staff General Research Papers 5249, Iowa State University, Department of Economics.
    10. Wang, Cheng, 1997. "Incentives, CEO Compensation and Shareholder Wealth in a Dynamic Agency Model," Staff General Research Papers 5170, Iowa State University, Department of Economics.
    11. Dale T. Mortensen & Christopher A. Pissarides, 1993. "Job Creation and Job Destruction in the Theory of Unemployment," CEP Discussion Papers dp0110, Centre for Economic Performance, LSE.
    12. Wang, Cheng, 1995. "Dynamic Insurance with Private Information and Balanced Budgets," Review of Economic Studies, Wiley Blackwell, vol. 62(4), pages 577-95, October.
    13. Lazear, Edward P, 1979. "Why Is There Mandatory Retirement?," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1261-84, December.
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    15. Atkeson, Andrew & Lucas, Robert E, Jr, 1992. "On Efficient Distribution with Private Information," Review of Economic Studies, Wiley Blackwell, vol. 59(3), pages 427-53, July.
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    17. W. Bentley MacLeod & James M. Malcomson, 1986. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Working Papers 585, Queen's University, Department of Economics.
    18. Wang, Cheng, 2000. "Renegotiation-Proof Dynamic Contracts with Private Information," Staff General Research Papers 5248, Iowa State University, Department of Economics.
    19. Zhao, Rui R., 2006. "Renegotiation-proof contract in repeated agency," Journal of Economic Theory, Elsevier, vol. 131(1), pages 263-281, November.
    20. Burdett, Kenneth & Mortensen, Dale T, 1998. "Wage Differentials, Employer Size, and Unemployment," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(2), pages 257-73, May.
    21. Stiglitz, Joseph E & Weiss, Andrew, 1983. "Incentive Effects of Terminations: Applications to the Credit and Labor Markets," American Economic Review, American Economic Association, vol. 73(5), pages 912-27, December.
    22. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
    23. Dilip Abreu & David Pearce & Ennio Stacchetti, 2010. "Towards a Theory of Discounted Repeated Games with Imperfect Monitoring," Levine's Working Paper Archive 199, David K. Levine.
    24. Abreu, Dilip & Pearce, David & Stacchetti, Ennio, 1990. "Toward a Theory of Discounted Repeated Games with Imperfect Monitoring," Econometrica, Econometric Society, vol. 58(5), pages 1041-63, September.
    25. Jovanovic, Boyan, 1979. "Job Matching and the Theory of Turnover," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 972-90, October.
    26. Atkeson Andrew & Lucas Jr. , Robert E., 1995. "Efficiency and Equality in a Simple Model of Efficient Unemployment Insurance," Journal of Economic Theory, Elsevier, vol. 66(1), pages 64-88, June.
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    Cited by:
    1. Jacek Rothert, 2009. "Monitoring, Moral Hazard and Turnover," Department of Economics Working Papers 130124, The University of Texas at Austin, Department of Economics, revised Sep 2012.
    2. Cheng Wang, 2012. "Optimal Self-enforcing and Termination," 2012 Meeting Papers 433, Society for Economic Dynamics.

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