Financing Constraints and Fixed-Term Employment Contracts

Abstract

This article studies the interactions between financing constraints and the employment decisions of firms when both fixed-term and permanent employment contracts are available. It develops the model of an industry where firms face financing frictions and produce output using both fixed-term and permanent workers. Once calibrated, the model shows that financially constrained firms use fixed-term workers more intensely and make them absorb a larger fraction of the total employment volatility than financially unconstrained firms do. We test and confirm the predictions of the model on a panel data of Italian manufacturing firms with detailed information about financing constraints and the type of workers employed by the firms.