Economic Theory

, Volume 18, Issue 1, pp 207–235 | Cite as

Dynamic labor contracts with temporary layoffs and permanent separations

  • Christopher Sleet
  • Şevin Yeltekin
Symposium Articles


We study the implications of optimal dynamic contracts in private information environments for fluctuations in effort and employment across time and productivity states. To this end, we incorporate temporary layoffs and permanent separations as well as on-the-job effort variations into a dynamic model of moral hazard. We consider two different “commitment” environments. In a “full commitment” environment, although the firm can temporarily lay a worker off, neither party can dissolve the contractual relationship once it has been initiated. On the other hand, in a “limited commitment” environment, both parties can dissolve the relationship at the beginning of any period in order to pursue an outside option.

We use our model to study the implications of optimal contracts for incentives, employment histories, layoffs and separations across full information, full commitment and limited commitment settings. We compute solutions to the relevant principal-agent problems, endogenously determining the set of states in which separations occur and the domain of the firm's value function, as well as the value function itself.

Keywords and Phrases: Dynamic contracts, Layoffs, Separations. 
JEL Classification Numbers: C63, D82, J23, J33. 


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Copyright information

© Springer-Verlag Berlin Heidelberg 2001

Authors and Affiliations

  • Christopher Sleet
    • 1
  • Şevin Yeltekin
    • 2
  1. 1.Department of Economics, University of Iowa, Iowa City IA 52242, USA (e-mail: US
  2. 2.Kellogg Graduate School of Management, Northwestern University, Evanston, IL 60208, USA (e-mail: US

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