Wage-Employment Contracts

This paper studies the efficient agreements about the dependence of workers' earnings on employment, when the employment level is controlled by firms. The firms ' superior information about profitability conditions is responsible for this form of contract governance. Under plausible assumptions, such agreements will cause employment to diverge from efficiency as a byproduct of their attempt to mitigate risk. It is shown that, if leisure is a normal good and firms are risk neutral, employment is always above the efficient level. Such a one-period implicit contracting model cannot, therefore, be used to "explain" unemployment as a rational byproduct of risk sharing between workers and a risk neutral firm under conditions of asymmetric information.