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On Employment Contracts with Heterogeneous Workers and Endogenous On-the-job Search


  • Francis Kiraly

    (Department of Economics Keele University,)


This paper considers an equilibrium search model with on-the-job search where firms set wages.We look at optimal employment contracts when workers are heterogeneous and choose search intensity. Firms may want to retain their good workers by matching any offers that these employees may receive from other firms. However, if workers are able to vary their search intensity, this ‘‘offer-matching’’ policy leads to a moral hazard problem. Workers are induced to search more intensively, which is costly. Assuming that firms can commit to retain and employ all workers, irrespective of their ability, we establish conditions under which it is optimal to do so. The idea is that firms can create an adverse selection situation that reduces outside offers from raiding firms. We describe equilibria where all firms use these so-called ‘‘pooling’’ contracts. The intuition is that the gains from reducing the returns to search may outweigh the costs of retaining all workers, including the low ability ones. We also derive conditions under which only ‘‘separating’’ contracts are offered and firms only retain the high ability workers. Some equilibria involve contracts where an ‘‘efficiency wage’’ is paid that again deters workers from actively looking for outside offers. Finally, we show that for a range of parameter values multiple equilibria are also possible.

Suggested Citation

  • Francis Kiraly, 2003. "On Employment Contracts with Heterogeneous Workers and Endogenous On-the-job Search," Keele Economics Research Papers KERP 2003/04, Centre for Economic Research, Keele University, revised Jan 2004.
  • Handle: RePEc:kee:kerpuk:2003/04 Note: Revised (January 2004) version of my (September 2003) paper entitled Layoffs and Promotions with Heterogeneous Workers and On-the-job Search.

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    References listed on IDEAS

    1. Deaton, Angus, 1991. "Saving and Liquidity Constraints," Econometrica, Econometric Society, vol. 59(5), pages 1221-1248, September.
    2. Mason, Robin & Wright, Stephen, 2001. "The effects of uncertainty on optimal consumption," Journal of Economic Dynamics and Control, Elsevier, vol. 25(1-2), pages 185-212, January.
    3. Stephen P. Zeldes, 1989. "Optimal Consumption with Stochastic Income: Deviations from Certainty Equivalence," The Quarterly Journal of Economics, Oxford University Press, vol. 104(2), pages 275-298.
    4. Kelly, Clare & Gauthier Lanot, 2002. "Consumption Patterns Over Pay Periods," The Warwick Economics Research Paper Series (TWERPS) 656, University of Warwick, Department of Economics.
    5. Carroll, Christopher D & Kimball, Miles S, 1996. "On the Concavity of the Consumption Function," Econometrica, Econometric Society, vol. 64(4), pages 981-992, July.
    6. Christopher D. Carroll, 2001. "A Theory of the Consumption Function, with and without Liquidity Constraints," Journal of Economic Perspectives, American Economic Association, vol. 15(3), pages 23-45, Summer.
    7. Deaton, Angus & Laroque, Guy, 1996. "Competitive Storage and Commodity Price Dynamics," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 896-923, October.
    8. Chambers, Marcus J & Bailey, Roy E, 1996. "A Theory of Commodity Price Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 924-957, October.
    9. Christopher D. Carroll & Miles S. Kimball, 2001. "Liquidity Constraints and Precautionary Saving," NBER Working Papers 8496, National Bureau of Economic Research, Inc.
    10. Rabault, Guillaume, 2002. "When do borrowing constraints bind? Some new results on the income fluctuation problem," Journal of Economic Dynamics and Control, Elsevier, vol. 26(2), pages 217-245, February.
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    More about this item


    labour market frictions; labour contracts; turnover; search effort; moral hazard and adverse selection.;

    JEL classification:

    • J31 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Wage Level and Structure; Wage Differentials
    • J41 - Labor and Demographic Economics - - Particular Labor Markets - - - Labor Contracts
    • J63 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Turnover; Vacancies; Layoffs
    • J64 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Unemployment: Models, Duration, Incidence, and Job Search


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