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Equilibrium Layoff As Termination of a Dynamic Contract

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  • Wang, Cheng
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    Abstract

    In a dynamic model of the labor market with moral hazard, equilibrium layoff is modeled as termination of an optimal long-term contract. Termination, together with compensation (current and future), is used as an incentive device to induce worker efforts. I then use the model to study analytically the effects of a firing tax on termination and worker compensation and utility. There are three layers to the impact of a firing tax on layoff and worker utility. A higher firing tax could either reduce aggregate termination and increase worker utility, or increase aggregate termination and reduce worker utility, depending on the structure of the environment.

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    File URL: http://www.econ.iastate.edu/sites/default/files/publications/papers/p3862-2006-12-11.pdf
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    Paper provided by Iowa State University, Department of Economics in its series Staff General Research Papers with number 12704.

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    Date of creation: 11 Dec 2006
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    Handle: RePEc:isu:genres:12704

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    Postal: Iowa State University, Dept. of Economics, 260 Heady Hall, Ames, IA 50011-1070
    Phone: +1 515.294.6741
    Fax: +1 515.294.0221
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    Web page: http://www.econ.iastate.edu
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    1. Spear, Stephen E. & Wang, Cheng, 2005. "When to fire a CEO: optimal termination in dynamic contracts," Journal of Economic Theory, Elsevier, Elsevier, vol. 120(2), pages 239-256, February.
    2. Wang, Cheng, 2005. "Termination of Dynamic Contracts in an Equilibrium Labor Market Model," Staff General Research Papers, Iowa State University, Department of Economics 12403, Iowa State University, Department of Economics.
    3. Hopenhayn, Hugo & Rogerson, Richard, 1993. "Job Turnover and Policy Evaluation: A General Equilibrium Analysis," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 101(5), pages 915-38, October.
    4. Mortensen, Dale T. & Pissarides, Christopher A., 1999. "New developments in models of search in the labor market," Handbook of Labor Economics, Elsevier, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 39, pages 2567-2627 Elsevier.
    5. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, American Economic Association, vol. 74(3), pages 433-44, June.
    6. Cheng Wang, 2005. "Termination of Dynamic Contracts in an Equilibrium Labor Market Model," 2005 Meeting Papers, Society for Economic Dynamics 743, Society for Economic Dynamics.
    7. 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.
    8. Garibaldi, Pietro & Violante, Giovanni L, 2002. "Firing Tax and Severance Payment in Search Economies: A Comparison," CEPR Discussion Papers, C.E.P.R. Discussion Papers 3636, C.E.P.R. Discussion Papers.
    9. Stiglitz, Joseph E & Weiss, Andrew, 1983. "Incentive Effects of Terminations: Applications to the Credit and Labor Markets," American Economic Review, American Economic Association, American Economic Association, vol. 73(5), pages 912-27, December.
    10. Fernando Alvarez & Marcelo Veracierto, 2000. "Labor-Market Policies in an Equilibrium Search Model," NBER Chapters, in: NBER Macroeconomics Annual 1999, Volume 14, pages 265-316 National Bureau of Economic Research, Inc.
    11. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 54(4), pages 599-617, October.
    12. Peter M. DeMarzo & Michael J. Fishman, 2007. "Optimal Long-Term Financial Contracting," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 20(6), pages 2079-2128, November.
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