Dismissal vs. Fines as a Discipline Device: Comment on Shapiro-Stiglitz

In their recent article "Equilibrium Unemployment as a Worker Discipline Device," Carl Shapiro and Joseph Stiglitz (1984) have analyzed what happens in a labor market if firms use dismissal as a sanction for workers detected shirking. Since dismissal must bite in order to serve as an effective threat, dismissal must cause a utility drop for the worker. Hence firms must offer wages above the opportunity wage level. In a cleared labor market, they have to offer wages above the prevailing wage rate, but if unemployment is sufficiently high, the utility drop caused by dismissal will suffice to render the threat of dismissal effective even without paying wages above the average, and the system settles down at such an equilibrium, There is, however, the possibility of using a fine instead of dismissal as a discipline device. The purpose of this note is to contrast dismissal and fines as discipline devices. I shall argue that the firm would prefer to choose a fine rather than dismissal in the Shapiro/Stiglitz setting. This conclusion is, however, unwarranted since dismissal is widely used as a threat (often as a threat of the last resort) and fines seem to be rather uncommon. Hence I propose that there are strong psychological reasons which suggest that fines undercut the workers' motivation, whereas the threat of dismissal does not. If the Shapiro/Stiglitz analysis is modified in order to take this into account, it becomes possible to indicate under which conditions dismissal rather than fines will be chosen.