The effects of firing costs on the wage contracts under adverse selection

Anne Bucher () and Sébastien Ménard

Working Papers of BETA from Bureau d'Economie Théorique et Appliquée, UDS, Strasbourg

Abstract: We develop a two-period principal-agent model to investigate the effects of firing costs on self-selection mechanisms and on the optimal wage contracts under adverse selection. There are two types of risk-averse workers who differ by their ability. The worker’s ability is private information but revealed once engaged in production. The adverse selection problem may be solve by workers’ selection from a menu of separating contracts that specifies a sequence of wages with dismissal being the only form of punishment to a worker who overstated his ability. We find that as firing costs increase, the wage-tenure profile of high-ability workers gets steeper while the information rent left to low-ability workers vanishes. For higher levels of firing costs, an incentive menu of contracts provides the most able workers with a lower starting wage than the less able workers. As the expected profit from separating contracts decreases with dismissal costs, there exists a threshold above which the employer prefers to offer a pooling wage that might drive good workers out of the labor market.

Keywords: Adverse Selection; Principal Agent; Labor Contracts; Wage; Firing Costs. (search for similar items in EconPapers)
JEL-codes: D82 J08 J31 J41 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-cta, nep-hrm and nep-lma
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Persistent link: https://EconPapers.repec.org/RePEc:ulp:sbbeta:2015-17

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