Optimal Coexistence of Long-term and Short-term contracts in Labor Markets∗

We consider a market where firms hire workers to run their projects and such projects differ in profitability. At any period, each firm needs two workers to successfully run its project: a junior agent, with no specific skills, and a senior worker, whose effort is not verifiable. Senior workers differ in ability and their competence is revealed after they have worked as juniors in the market. We study the length of the contractual relationships between firms and workers in an environment where the matching between firms and workers is the result of market interaction. We show that, despite in a one-firm-one-worker set-up long-term contracts are the optimal choice for firms, market forces often induce firms to use short-term contracts. Unless the market only consists of firms with very profitable projects, firms operating highly profitable projects offer short-term contracts to ensure the service of high-ability workers and those with less lucrative projects also use short-term con∗We are grateful to the participants at the seminar at CREST (Paris, 2011) for their insightful comments. Financial support from Ministerio de Ciencia y Tecnología (ECO2008-04321 and ECO2009— 07616), Generalitat de Catalunya (2009SGR-169), Junta de Andalucía (SEJ-02936 and SEJ-04992), Barcelona Graduate School of Economics and ICREA Academia is gratefully acknowledged. The first two authors are fellows of MOVE. †Universitat Autonoma de Barcelona Barcelona GSE; Dept. Economía e Hist. Económica; Edificio B; 08193 Bellaterra Barcelona; Spain. Email: [email protected]. ‡Corresponding author. Universitat Autonoma de Barcelona Barcelona GSE; Dept. Economía e Hist. Económica; Edificio B; 08193 Bellaterra Barcelona; Spain. Email: [email protected]. §Department of Economics (Universidad Pablo Olavide). Email: [email protected].