Layoffs and Lemons

In this paper we provide theoretical and empirical analyses of an asymmetric-information model of layoffs in which the current employer is better informed about its workers' abilities than prospective employers are. The key feature of the model is that when firms have discretion with respect to whom to lay off, the market infers that laid-off workers are of low ability. Since no such negative inference should be attached o workers displaced in a plant closing, our model predicts that the postdisplacement wages of otherwise observationally equivalent workers will be higher for those displaced by plant closings than for those displaced by layoffs. An extension of our model predicts that the average postdisplacement unemployment spell of otherwise observationally equivalent workers will be shorter for those displaced by plant closings than for those displaced by layoffs. In our empirical work, we use data from the Displaced Workers Supplements in the January 1984 and 1986 Current Population Surveys. We find that the evidence (with respect to both re-employment wages and postdisplacement unemployment duration) is consistent with the idea that laid off workers are viewed less favorably by the market than are those losing jobs in plant closings. Our findings are much stronger for workers laid off from jobs where employers have discretion over whom to lay off.