Contractual Employment Protection and the Scarring Risk of Unemployment

44 Pages Posted: 7 Nov 2005

See all articles by Elke J. Jahn

Elke J. Jahn

Institute for Employment Research (IAB); University of Bayreuth; IZA Institute of Labor Economics

Thomas Wagner

University of Applied Sciences Nurnberg

Date Written: October 2005


Risk-averse job seekers fearing the scarring effect of unemployment meet vacancies offering contractual employment protection (CEP) in form of guaranteed employment (GEC) or severance pay contracts (SPC). A GEC fully eliminates both the income risk and the scarring risk of unemployment. SPC diversify the income risk, but provide only limited protection against the scarring risk. (1) Workers strictly prefer contract market to spot market jobs. (2) A higher productivity, a lower probability of demand shocks or of finding a re-employment after a dismissal as well as lower public unemployment benefits increase the fraction of workers concluding a GEC. (3) Although firms are risk-neutral, first-best SPC are not incentive compatible under asymmetric information on the demand for the output of the job. In the second-best equilibrium, a positive fraction of over-insured workers will conclude a GEC, while workers signing a SPC incur income risk. (4) With asymmetric information on the reemployment status of a dismissed worker, employees who conclude a third-best SPC face both uninsurable income risk and the unemployment scar. Workers with a precautionary motive who expect a large or long lasting scar, conclude SPC with wage replacement rates strictly larger than one and low recession wages, which make their jobs more viable.

Keywords: scarring effect of unemployment, contractual employment protection, guaranteed employment contract, severance pay contract, implicit contract, moral hazard, prudence

JEL Classification: J31, J32, J81

Suggested Citation

Jahn, Elke J. and Wagner, Thomas, Contractual Employment Protection and the Scarring Risk of Unemployment (October 2005). IZA Discussion Paper No. 1813, Available at SSRN:

Elke J. Jahn (Contact Author)

Institute for Employment Research (IAB) ( email )

Regensburger Str. 104
Nuremberg, 90478

University of Bayreuth ( email )

Bayreuth, 95447

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072

Thomas Wagner

University of Applied Sciences Nurnberg ( email )

90489 Nurenberg

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