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A real options analysis of dual labor markets and the single labor contract

  • Gete, Pedro
  • Porchia, Paolo
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    We study the optimal hiring and firing decisions of a firm under two different firing costs regulations: 1) Dual labor markets characterized by high firing costs for workers with seniority above a threshold ("permanent workers") and by low costs for "temporary workers". 2) The Single Labor Contract, a policy proposal to make firing costs increasing in seniority at the job. We focus on the option value implied by the regulations and obtain some new results: the optimal firing rule is a constant function of worker's productivity only for permanent workers. For temporary workers it varies with seniority at the job because the firm tries to keep alive the option to fire at low cost. In the Dual regulation the workers more likely to be fired are those close to become permanent. On the contrary, the Single Contract transfers that maximum firing to the new hires. Thus, fired workers are fired sooner under the Single Contract. However, if both regulations have the same average firing cost for workers who become permanent, temporary workers are less likely to be fired in the Single Contract. Moreover, this new regulation increases hiring and average employment duration. It also reduces turnover among temporary workers, but at the expense of higher turnover among permanent workers who are more often replaced by temporary workers.

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    File URL: http://mpra.ub.uni-muenchen.de/34055/1/MPRA_paper_34055.pdf
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    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 34055.

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    Date of creation: Oct 2011
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    Handle: RePEc:pra:mprapa:34055
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    1. Miao, Jianjun & Wang, Neng, 2007. "Investment, consumption, and hedging under incomplete markets," Journal of Financial Economics, Elsevier, vol. 86(3), pages 608-642, December.
    2. Hector Sala & Jose I. Silva & Manuel E. Toledo, 2007. "Flexibility at the margin and labor market volatility in OECD countries," Economics Working Papers we075832, Universidad Carlos III, Departamento de Economía.
    3. Hui Chen, 2010. "Macroeconomic Conditions and the Puzzles of Credit Spreads and Capital Structure," Journal of Finance, American Finance Association, vol. 65(6), pages 2171-2212, December.
    4. Dolado, Juan J. & Jansen, Marcel & Jimeno, Juan F., 2007. "A Positive Analysis of Targeted Employment Protection Legislation," IZA Discussion Papers 2679, Institute for the Study of Labor (IZA).
    5. Harjoat S. Bhamra & Lars-Alexander Kuehn & Ilya A. Strebulaev, 2010. "The Aggregate Dynamics of Capital Structure and Macroeconomic Risk," Review of Financial Studies, Society for Financial Studies, vol. 23(12), pages 4187-4241, December.
    6. Samuel Bentolila & Pierre Cahuc & Juan J. Dolado & Thomas Le Barbanchon, 2010. "Two-Tier Labor Markets In The Great Recession: France Vs. Spain," Working Papers wp2010_1009, CEMFI.
    7. Cahuc, Pierre & Postel-Vinay, Fabien, 2002. "Temporary jobs, employment protection and labor market performance," Labour Economics, Elsevier, vol. 9(1), pages 63-91, February.
    8. Hugonnier, Julien & Morellec, Erwan, 2007. "Corporate control and real investment in incomplete markets," Journal of Economic Dynamics and Control, Elsevier, vol. 31(5), pages 1781-1800, May.
    9. Tito Boeri & Pietro Garibaldi, 2007. "Two Tier Reforms of Employment Protection: A Honeymoon Effect?," Carlo Alberto Notebooks 37, Collegio Carlo Alberto.
    10. Victoria Osuna & Jose-Ignacio García-Pérez, 2012. "The effects of introducing a single open-ended contract in Spain," EcoMod2012 3825, EcoMod.
    11. Bentolila, Samuel & Bertola, Giuseppe, 1990. "Firing Costs and Labour Demand: How Bad Is Eurosclerosis?," Review of Economic Studies, Wiley Blackwell, vol. 57(3), pages 381-402, July.
    12. Carr, Peter, 1998. "Randomization and the American Put," Review of Financial Studies, Society for Financial Studies, vol. 11(3), pages 597-626.
    13. James Costain & Juan F. Jimeno & Carlos Thomas, 2010. "Employment fluctuations in a dual labor market," Banco de Espa�a Working Papers 1013, Banco de Espa�a.
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