A Real Options Analysis of Dual Labor Markets and the Single Labor Contract

17 Pages Posted: 12 Oct 2011 Last revised: 12 Jun 2013

Pedro Gete

Georgetown University; IE Business School

Paolo Porchia

IE Business School

Date Written: May 1, 2013

Abstract

We study the hiring and firing decisions of a firm in a Dual Labor market and in a Single Labor Contract. Under both regulations, to fire before a certain seniority threshold is similar to an American option that gives the right of firing at low costs. However, the value of the option is different in each regulation. Our model takes into account the value of this option to analyze a firm's firing and hiring behavior. We study the role of the firm's risk aversion, and of the growth and volatility of the firm's profits. In our model the maximum allowed duration of temporary contracts is deterministic. Three channels drive the firing decisions: 1) A "substitution effect" to replace existing workers with new hires with lower firing costs; 2) An "anticipation effect" in which the expectations of increasing firing costs pushes towards early firing; and 3) The value of the option to fire at low costs. Our main results are: 1) In the Dual regulation most of firing happens just before the worker becomes permanent. 2) The Single Contract implies higher expected duration at the job, less job churning and less unemployment. However, in the Single Contract, workers that are fired are fired sooner, and permanent workers are more likely to be fired.

Keywords: Single Contract, Dual Labor, Real Options

Suggested Citation

Gete, Pedro and Porchia, Paolo, A Real Options Analysis of Dual Labor Markets and the Single Labor Contract (May 1, 2013). Available at SSRN: https://ssrn.com/abstract=1942048 or http://dx.doi.org/10.2139/ssrn.1942048

Pedro Gete (Contact Author)

Georgetown University ( email )

ICC 580
37th and O Sts., NW
Washington, DC 20057
United States

HOME PAGE: http://www9.georgetown.edu/faculty/pg252/

IE Business School

Calle Maria de Molina 12, Bajo
Madrid, Madrid 28006
Spain

Paolo Porchia

IE Business School ( email )

Serrano 99
Madrid, 28006
Spain
+34917821706 (Phone)
+34 91 745 47 62 (Fax)

HOME PAGE: http://paolo-porchia.profesores.ie.edu/

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