Pareto-improving firing costs?

Bilgehan Karabay and John McLaren

European Economic Review, 2011, vol. 55, issue 8, 1083-1093

Abstract: We examine self-enforcing contracts between risk-averse workers and risk-neutral firms (the ‘invisible handshake’) in a labor market with search frictions. Employers promise as much wage-smoothing as they can, consistent with incentive conditions that ensure they will not renege during low-profitability times. Equilibrium is inefficient if these incentive constraints bind, with risky wages for workers and a risk premium that employers must pay. Mandatory firing costs can help, by making it easier for employers to promise credibly not to cut wages in low-profitability periods. We show that firing costs are more likely to be Pareto-improving if they are not severance payments.

Keywords: Implicit contracts; Invisible handshake; Firing costs (search for similar items in EconPapers)
JEL-codes: F10 F16 J63 (search for similar items in EconPapers)
Date: 2011
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:55:y:2011:i:8:p:1083-1093

DOI: 10.1016/j.euroecorev.2011.04.008

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