Optimal Labor Contracts with On-the-Job Search: Are Involuntary Layoffs Used as an Incentive Device to Make Workers Search Harder?

Abstract

This article considers the form of the optimal implicit contract when workers have private information about their opportunity wage obtained via costly on-the-job search. It is assumed that the workers' search intensity is unobservable by the firm. Hence, the optimal contract must reconcile the incentives to promote intensive search with the incentives for the worker to reveal truthfully his opportunity wage. Its properties are demonstrated in the case of simple self-selection contracts, contracts with a lower bound on the severance payment, and contracts with involuntary layoffs.