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Optimal Coexistence of Long-Term and Short-Term Contracts in Labor Markets

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  • Inés Macho-Stadler
  • David Pérez-Castrillo
  • Nicolés Porteiro

Abstract

We consider a market where firms hire workers to run their projects and such projects differ in profitability. At any period, each firm needs two workers to successfully run its project: a junior agent, with no specific skills, and a senior worker, whose effort is not verifiable. Senior workers differ in ability and their competence is revealed after they have worked as juniors in the market. We study the length of the contractual relationships between firms and workers in an environment where the matching between firms and workers is the result of market interaction. We show that, despite in a one-firm-one-worker set-up long-term contracts are the optimal choice for firms, market forces often induce firms to use short-term contracts. Unless the market only consists of firms with very profitable projects, firms operating highly profitable projects offer short-term contracts to ensure the service of high-ability workers and those with less lucrative projects also use short-term contracts to save on the junior workers wage. Intermediate firms may (or may not) hire workers through long-term contracts.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 557.

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Date of creation: May 2011
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Handle: RePEc:bge:wpaper:557

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Keywords: Moral Hazard; long-term contracts; equilibrium contracts;

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  1. Patrick Legros & Andrew F. Newman, 2007. "Beauty Is a Beast, Frog Is a Prince: Assortative Matching with Nontransferabilities," Econometrica, Econometric Society, Econometric Society, vol. 75(4), pages 1073-1102, 07.
  2. Suman Ghosh & Michael Waldman, 2010. "Standard promotion practices versus up-or-out contracts," RAND Journal of Economics, RAND Corporation, RAND Corporation, vol. 41(2), pages 301-325.
  3. Chiappori, P.A. & Macho, I. & Rey, p. & Salanie, B., 1994. "Repeated Moral Hazard: The Role of Memory, Commitment, and the Acces to Credit Markets," Papers, Laval - Laboratoire Econometrie 06, Laval - Laboratoire Econometrie.
  4. Matutes, Carmen & Regibeau, Pierre & Rockett, Katharine, 1994. "Compensation Schemes and Labor Market Competition: Piece Rate versus Wage Rate," Journal of Economics & Management Strategy, Wiley Blackwell, Wiley Blackwell, vol. 3(2), pages 325-53, Summer.
  5. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, Econometric Society, vol. 53(1), pages 69-76, January.
  6. Marko Tervi�, 2009. "Superstars and Mediocrities: Market Failure in the Discovery of Talent -super-1," Review of Economic Studies, Oxford University Press, vol. 76(2), pages 829-850.
  7. Ghatak, Maitreesh & Morelli, Massimo & Sjostrom, Tomas, 2001. "Occupational Choice and Dynamic Incentives," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 68(4), pages 781-810, October.
  8. Eng Loh, 1994. "Employment probation as a sorting mechanism," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 47(3), pages 471-486, April.
  9. Konstantinos Serfes, 2008. "Endogenous matching in a market with heterogeneous principals and agents," International Journal of Game Theory, Springer, Springer, vol. 36(3), pages 587-619, March.
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Cited by:
  1. Cahuc, Pierre & Charlot, Olivier & Malherbet, Franck, 2012. "Explaining the Spread of Temporary Jobs and its Impact on Labor Turnover," CEPR Discussion Papers, C.E.P.R. Discussion Papers 8864, C.E.P.R. Discussion Papers.

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