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A Theory of the Firm with Non-Binding Employment Contracts

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  • Asher Wolinsky

Abstract

The purpose of this paper is ti develop the theory of the firm to get better understanding of situations in which individual employees enjoy some bargaining power in their relations with the firm, and in which the terms of employment are determined and adjusted through individual contracting and recontracting with the firm. The main elements of the situations studied here are that the employees are not organized, that the employment contracts are nonbinding or at least not for very long, and that the firm has opportunities to replace employees. The paper develops analyzes a dynamic model in which the processes of contarcting and re-contracting between the firm and its employees are intertwined with the dynamic evolution of the firm's workforce. The analysis of the model is somewhat complicated because the employmest level is a non-degenerate state variable that evolves over time and is affected by past decisions. The main analytical results characterize certain important equilibria: the profit maximizing, profit minimizing and stationary equilibria. The unique stationary equilibrium is markedly inefficient: it exhibits inefficient over-employment and the steady state wages coincide with the workers' reservation wage. It confirms earlier results derived by Stole and Zwiebel (1996a,b) in the contextof a static model and shows that they are very robust even when the firm has nearly frictionless hiring opportunities. In contrast, the profit maximizing equilibrium captures a very different pattern. The outcome is nearly efficient and the wage exhibits a mark-up over the reservation wage. The path of the wages exhibits an interesting behavior--it declines sharply when it reaches its steady state level

Suggested Citation

  • Asher Wolinsky, 1997. "A Theory of the Firm with Non-Binding Employment Contracts," Discussion Papers 1194, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    • Handle: RePEc:nwu:cmsems:1194
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    References listed on IDEAS

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    1. Horn, Henrik & Wolinsky, Asher, 1988. "Worker Substitutability and Patterns of Unionisation," Economic Journal, Royal Economic Society, vol. 98(391), pages 484-497, June.
    2. Jackson, Matthew O. & Wolinsky, Asher, 1996. "A Strategic Model of Social and Economic Networks," Journal of Economic Theory, Elsevier, vol. 71(1), pages 44-74, October.
    3. Grout, Paul A, 1984. "Investment and Wages in the Absence of Binding Contracts: A Nash Bargining Approach," Econometrica, Econometric Society, vol. 52(2), pages 449-460, March.
    4. Henrick Horn & Asher Wolinsky, 1988. "Bilateral Monopolies and Incentives for Merger," RAND Journal of Economics, The RAND Corporation, vol. 19(3), pages 408-419, Autumn.
    5. Asher Wolinsky, 2000. "A Theory of the Firm with Non-Binding Employment Contracts," Econometrica, Econometric Society, vol. 68(4), pages 875-910, July.
    6. Stole, Lars A & Zwiebel, Jeffrey, 1996. "Organizational Design and Technology Choice under Intrafirm Bargaining," American Economic Review, American Economic Association, vol. 86(1), pages 195-222, March.
    7. Lars A. Stole & Jeffrey Zwiebel, 1996. "Intra-firm Bargaining under Non-binding Contracts," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 63(3), pages 375-410.
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    Citations

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    Cited by:

    1. Pierre Cahuc & Fabien Postel-Vinay & Jean-Marc Robin, 2006. "Wage Bargaining with On-the-Job Search: Theory and Evidence," Econometrica, Econometric Society, vol. 74(2), pages 323-364, March.
    2. Catherine C. de Fontenay & Joshua S. Gans, 2003. "Organizational Design and Technology Choice under Intrafirm Bargaining: Comment," American Economic Review, American Economic Association, vol. 93(1), pages 448-455, March.
    3. William Hawkins & Daron Acemoglu, 2007. "Equilibrium Unemployment in a Generalized Search Model," 2007 Meeting Papers 384, Society for Economic Dynamics.
    4. Marini, Marco A., 2006. "The value of a new idea: knowledge transmission, workers’ mobility and market structure," Chaos, Solitons & Fractals, Elsevier, vol. 29(3), pages 697-706.
    5. William H. Greene & Ana P. Martins, 2002. "Striking Features of the Labor Market," EERI Research Paper Series EERI RP 2002/08, Economics and Econometrics Research Institute (EERI), Brussels.
    6. Konrad, Kai A. & Morath, Florian, 2016. "Bargaining with incomplete information: Evolutionary stability in finite populations," Journal of Mathematical Economics, Elsevier, vol. 65(C), pages 118-131.
    7. William H. Greene & Ana P. Martins, 2013. "Striking Features of the Labor Market: Theory," Journal of Economics and Econometrics, Economics and Econometrics Society, vol. 56(2), pages 1-24.
    8. Marc-Andreas Muendler & Sascha O. Becker, 2010. "Margins of Multinational Labor Substitution," American Economic Review, American Economic Association, vol. 100(5), pages 1999-2030, December.
    9. Gregory Veramendi, 2012. "Labor Market Dynamics: A Model of Search and Human Capital Accumulation," 2012 Meeting Papers 1059, Society for Economic Dynamics.
    10. Asher Wolinsky, 2000. "A Theory of the Firm with Non-Binding Employment Contracts," Econometrica, Econometric Society, vol. 68(4), pages 875-910, July.
    11. Ayşe Mumcu, 2010. "Strategic Withholding Of Firm‐Specific Skills In Wage Bargaining," Scottish Journal of Political Economy, Scottish Economic Society, vol. 57(2), pages 187-211, May.
    12. Björnerstedt, Jonas & Westermark, Andreas, 2006. "Bargaining and Strategic Discrimination," Working Paper Series 2006:6, Uppsala University, Department of Economics.
    13. Lopez-Martin, Bernabe & Perez-Reyna, David, 2021. "Contracts, firm dynamics, and aggregate productivity," Journal of Economic Dynamics and Control, Elsevier, vol. 130(C).
    14. Razin, Ronny & Baccara, Mariagiovanna, 2004. "Curb Your Innovation: Corporate Conservatism in the Presence of Imperfect Intellectual Property Rights," CEPR Discussion Papers 4466, C.E.P.R. Discussion Papers.
    15. Monique Ebell & Christian Haefke, 2002. "Product market deregulation and labor market outcomes," Economics Working Papers 726, Department of Economics and Business, Universitat Pompeu Fabra, revised Dec 2003.
    16. Christian Haefke & Monique Ebell, 2004. "The Missing Link: Product Market Regulation, Collective Bargaining and the European Unemployment Puzzle," 2004 Meeting Papers 759, Society for Economic Dynamics.
    17. Irlenbusch, Bernd, 2004. "Relying on a man's word?: An experimental study on non-binding contracts," International Review of Law and Economics, Elsevier, vol. 24(3), pages 299-332, September.
    18. Kurmann, André, 2014. "Holdups and overinvestment in capital markets," Journal of Economic Theory, Elsevier, vol. 151(C), pages 88-113.
    19. Gabriel Felbermayr & Julien Prat, 2011. "Product Market Regulation, Firm Selection, And Unemployment," Journal of the European Economic Association, European Economic Association, vol. 9(2), pages 278-317, April.
    20. Ronny Razin & Mariagiovanna Baccara, 2008. "Bargaining Over New Ideas: Rent Distribution and Stability of Innovative Firms," Working Papers 08-6, New York University, Leonard N. Stern School of Business, Department of Economics.
    21. ., 2012. "Models of Negotiation and Bargaining in Health Care," Chapters, in: Andrew M. Jones (ed.), The Elgar Companion to Health Economics, Second Edition, chapter 21, Edward Elgar Publishing.
    22. Catherine de Fontenay & Joshua Gans, 2004. "Sequential Bilateral Bargaining and the Shapley value," Econometric Society 2004 Australasian Meetings 84, Econometric Society.
    23. Mumcu, Ayşe, 1999. "Firm-Specific Skills, Wage Bargaining, and Efficiency," MPRA Paper 1913, University Library of Munich, Germany.

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