Implicit Contracts and Underemployment Equilibria

Abstract

This paper studies an industry with demand uncertainty which prompts risk-neutral firms to act both as employers and as insurers of homogeneous, risk-averse laborers. The resulting contractual arrangements turn out, in their simplest form, to be more likely to specify full employment the more of the following conditions prevail: small variability in product price, above-average economy-wide labor demand, highly risk-averse workers, small unemployment compensation, and highly competitive product market. Otherwise, it may be optimal for firms to lay off, by random choice, part of the work force during low states of demand.