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Labor and credit contracts with asymmetric information and bankruptcy

Authors
Journal
European Economic Review
0014-2921
Publisher
Elsevier
Publication Date
Volume
40
Issue
8
Identifiers
DOI: 10.1016/0014-2921(95)00039-9
Keywords
  • Asymmetric Information
  • Limited Liability
  • Worker Mobility
Disciplines
  • Economics

Abstract

Abstract This paper investigates the interaction between a firm's contracts for labor and its contracts for credit under asymmetric information and limited liability, when workers are either always committed to their contract or they lack the power to commit ex post because arbitrage opportunities are available to them. The analysis contains two main results: First, contrary to the perceptions of the limited liability literature, where limited liability is thought of causing both underemployment and income underinsurance, limited liability is in fact shown to only cause underemployment. Existence of outside sources of credit eliminates the underinsurance side of the inefficiency, but can not eliminate underemployment. Second, the factor that does cause underinsurance is the existence of ex post arbitrage opportunities for the worker. Worker mobility leads to underinsurance regardless of whether limited liability is binding or not and even if outside sources of credit exist. Thus, underemployment stems from limited liability, and underinsurance stems from worker mobility.

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