Why Do Firms Offer 'Employment Protection'?

To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.1111/j.1468-0335.2010.00861.x Byline: CHRISTOPHER A. PISSARIDES ([dagger]) Abstract: This paper derives optimal employment contracts when workers are risk-averse and there are employment and unemployment risks. Without income insurance, consumption rises during employment and falls during unemployment. Optimal employment contracts offer severance compensation and sometimes give notice before dismissal. Severance compensation smooths consumption during employment, and dismissal delays insure partially against the unemployment risk because of moral hazard. During the delay, consumption falls to give incentives to the worker to search for another job. No dismissal delays are optimal if exogenous unemployment compensation is sufficiently generous. Author Affiliation: ([dagger])Centre for Economic Performance, London School of Economics, IZA and CEPR Article History: Final version received 13 January 2010.