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Pareto-improving firing costs?

  • Karabay, Bilgehan
  • McLaren, John

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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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
DOI: 10.1016/j.euroecorev.2011.04.008
Contact details of provider: Web page: http://www.elsevier.com/locate/eer

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  1. Niko Matouschek & P Ramezzana & Frédéric Robert-Nicoud, 2008. "Labor Market Reforms, Job Instability, and the Flexibility of the Employment Relationship," CEP Discussion Papers dp0865, Centre for Economic Performance, LSE.
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  13. repec:adr:anecst:y:1995:i:37-38 is not listed on IDEAS
  14. Pissarides, Christopher A., 2001. "Employment protection," Labour Economics, Elsevier, vol. 8(2), pages 131-159, May.
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  19. repec:adr:anecst:y:1995:i:37-38:p:03 is not listed on IDEAS
  20. Adriana D. Kugler & Gilles Saint-Paul, 2004. "How Do Firing Costs Affect Worker Flows in a World with Adverse Selection?," Journal of Labor Economics, University of Chicago Press, vol. 22(3), pages 553-584, July.
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