Profit-Sharing and Optimal Labour Contracts

Abstract

This paper examines the effect of introducing profit-sharing arrangements into union- firm contracts. It is shown that if bargaining is efficient (using the generalized Nash bargain), profit-sharing has no effect on the bargaining outcome. This is true both when the profit-sharing restriction is exogenously imposed by legislation and when profit-sharing is part of the optimal contract. However, if the initial bargaining process is inefficient because direct negotiation on total employment is precluded, an optimal contract can use profit-sharing to establish the efficient bargaining outcome. Both types of bargaining models have been employed in the literature.