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A Sorting Model of Labor Contracts: Implications for Layoffs and Wage-Tenure Profiles

  • Andrew Weiss
  • Ruqu Wang

This paper analyzes a sorting model of labor contracts when workers have private information about their own productivities, and firms can test (monitor) workers. We show that sorting considerations alone generate steep wage-tenure profiles, high turnover rates of newly hired workers, and mandatory retirement rules. We find that if test results are only informative to the testing firm, and hiring is costless, then all workers that fail the test are fired. When hiring is costly, we derive conditions under which the firm retains sane (or all) workers that fail its test. We also derive conditions under which the firm tests sane, but not all, of its workers. In the second part of this paper, we consider the case when there are no hiring costs and there are many identical firms competing for the good type workers. we characterize the optimal contracts am show that competition for workers can lower total output. This is because competition can induce firms to increase the proportion of their workers that they test, rot it the test is costly, this lowers output. Finally, we show that because a mandated minimum wage affects the probability of a firm testing its worker's, an increase in the minimum wage can increase (or decrease) aggregate output.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 3448.

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Date of creation: Sep 1990
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Publication status: Published as "Probation, Layoffs, and Wage-Tenure Profiles: A Sorting Explanation", LABECON, Vol. 5, no. 5 (September 1998): 359-383.
Handle: RePEc:nbr:nberwo:3448
Note: LS
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  1. Kletzer, Lori Gladstein, 1989. "Returns to Seniority after Permanent Job Loss," American Economic Review, American Economic Association, vol. 79(3), pages 536-43, June.
  2. Robert H. Topel, 1990. "Specific Capital, Mobility, and Wages: Wages Rise with Job Seniority," NBER Working Papers 3294, National Bureau of Economic Research, Inc.
  3. Calvo, Guillermo A & Wellisz, Stanislaw, 1979. "Hierarchy, Ability, and Income Distribution," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 991-1010, October.
  4. Alan B. Krueger, 1991. "The evolution of unjust-dismissal legislation in the United States," Industrial and Labor Relations Review, ILR Review, Cornell University, ILR School, vol. 44(4), pages 644-660, July.
  5. Bentley MacLeod & James M. Malcomson, 1985. "Reputation and Hierarchy in Dynamic Models of Employment," Working Papers 628, Queen's University, Department of Economics.
  6. Katharine G. Abraham & Henry S. Farber, 1986. "Job Duration, Seniority and Earnings," Working papers 407, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Salop, Joanne & Salop, Steven, 1976. "Self-Selection and Turnover in the Labor Market," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 619-27, November.
  8. Guasch, J Luis & Weiss, Andrew, 1980. "Wages as Sorting Mechanisms in Competitive Markets with Asymmetric Information: A Theory of Testing," Review of Economic Studies, Wiley Blackwell, vol. 47(4), pages 653-64, July.
  9. Burdett, K. & Mortensen, Dale T., 1981. "Testing for ability in a competitive labor market," Journal of Economic Theory, Elsevier, vol. 25(1), pages 42-66, August.
  10. Joseph Altonji & R. Shakotko, 1985. "Do Wages Rise with Job Seniority?," Working Papers 567, Princeton University, Department of Economics, Industrial Relations Section..
  11. Gibbons, Robert & Katz, Lawrence F, 1991. "Layoffs and Lemons," Journal of Labor Economics, University of Chicago Press, vol. 9(4), pages 351-80, October.
  12. Nalebuff, Barry & Scharfstein, David, 1987. "Testing in Models of Asymmetric Information," Review of Economic Studies, Wiley Blackwell, vol. 54(2), pages 265-77, April.
  13. Mathias Dewatripont, 1989. "Renegotiation and information revelation over time: the case of optimal labor contacts," ULB Institutional Repository 2013/9573, ULB -- Universite Libre de Bruxelles.
  14. Joanne Salop & Steve Salop, 1976. "Self-selection and turnover in the labor market," Special Studies Papers 80, Board of Governors of the Federal Reserve System (U.S.).
  15. Lazear, Edward P, 1979. "Why Is There Mandatory Retirement?," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1261-84, December.
  16. George A. Akerlof & Lawrence F. Katz, 1986. "Do Deferred Wages Dominate Involuntary Unemployment as a Worker Discipline Device?," NBER Working Papers 2025, National Bureau of Economic Research, Inc.
  17. Marshall, Robert C & Zarkin, Gary A, 1987. "The Effect of Job Tenure on Wage Offers," Journal of Labor Economics, University of Chicago Press, vol. 5(3), pages 301-24, July.
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