Center for Economic Research, Department of Economics, University of Minnesota
This paper considers characteristics of labor contracts between
the risk-neutral firm and risk-averse workers who have heterogeneous
outside opportunities (alternative wages). The alternative wage, not
verifiable by the firm, becomes known to the worker after costly on the
job search. The worker voluntarily quits if the outside wage is
higher than the contract wage in the firm.
If the alternative wage is deterministic, then self-selection
among workers over a menu of contract wages would achieve the firstbest
with efficient allocation of workers in different firms (industries),
i.e., productive efficiency, and perfect risk-sharing.
If the alternative wages are stochastic, the second-best contract
would emerge on a tradeoff between productive efficiency and
risk-sharing. Workers who are induced to search in the second-best
contracts are fewer than in the first-best; and workers given search
are less likely to quit than the first-best. The severance payment
for a voluntary leaver serves only incomplete insurance because the
exact outcome of search is not known to the firm; and unsuccessful
search which force workers to stay is only partially compensated. If
search effort is not monitored, even fewer workers conduct search.
In sum, workers' stochastic alternative wages, which is a private
information, yield a contract which induces workers to conduct
less search and quits less often than the first-best.
Ito, T., (1986), "Labor Contracts with Voluntary Quits", Discussion Paper No. 233, Center for Economic Research, Department of Economics, University of Minnesota.
Labor Contracts with Voluntary Quits.
Center for Economic Research, Department of Economics, University of Minnesota.
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