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Why do firms use fixed-term contracts?

Abstract

In this article we look at how one specific form of temporary employment - employment with fixed-term contracts - fits into employers’ hiring policies. We find that human capital variables, measured at the levels of the worker and the workplace, are important determinants of the employers’ decisions to hire with temporary contracts and to promote temporary workers to permanent positions. Those employers that hire more with temporary contracts are also those that are more likely to offer a permanent position to their newly-hired temporary employees. Our results indicate that fixed-term contracts are a mechanism for screening workers for permanent positions.

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Notes

  1. Notice, however, that Hunt (2000) and Maurin (2000), among other authors, dispute the fact that fixed-term contracts actually offer firms increased flexibility because of the restrictions that typically apply to the rolling over of these contracts.

  2. On the conspicuous nature of the Portuguese labor market, see Blanchard and Portugal (2001) and Varejão and Portugal (2007).

  3. The strictness of the overall EPL legislation is especially due to the protection of permanent workers against individual dismissal. As a result, Portugal occupies the first position (alongside Turkey) in the OECD ranking of the most stringent employment protection legislation in Europe, although it occupies an intermediate position if we only consider the regulation of temporary employment (OECD 1999, 2004). Legislation on dismissals and fixed-term contracts did not change significantly over the period covered by our analysis (1995-2003). With minor amendments, the law on fixed-term contracts dates back to 1989 and the law on dismissals to 1991. They were both in place until 2004, when a new labor law was adopted.

  4. For a thoughtful presentation of the beta-binomial regression model, see Santos Silva and Murteira (2009). We thank João Santos Silva for kindly providing us with the TSP codes for the beta-binomial model.

  5. The estimation procedure automatically weighs each observation by the corresponding risk set. That is, in the incidence of fixed-term contracts equation, the observations are (implicitly) weighted by the number of employees; in the transition to permanent employment equation the observations are weighted by the number of workers with fixed-term contracts.

  6. Despite our best efforts, we were unable to gather the data necessary to expand the time period of our analysis. Nevertheless, it worth mentioning that since 2010 the information usually collected in Balanço Social was incorporated in the Quadros de Pessoal survey, which changed its name to Inquérito Único. Regrettably, the Ministry of Employment does not make this information available to researchers.

  7. For consistency, we use the corresponding count of the total number of employees, instead of the year average, which is also reported.

  8. Data from Quadros de Pessoal are refer to the month of October of the corresponding year.

  9. The specific stata code used to estimate these beta-binomial models is available in the on-line appendix. We reemphasize that the generic code was generously supplied to us by João Santos Silva.

  10. It could be argued that some workers were hired prior to the introduction of fixed-term contracts and therefore could not have been offered such contracts. However, because fixed-term contracts were introduced in Portugal as early as 1978 and a cap on their duration always existed (and never exceeded three years over the sample period) it is adequate to assume that the inability to use fixed-term contracts some twenty years prior to the period we study is irrelevant to the problem we are addressing. We are assuming that all workers could have a fixed-term contract if the firm dismissed all workers with permanent contracts and hired replacement workers.

  11. All workers are administratively assigned one skill-level out of eight possibilities on the basis of their occupation and level of education. The eight skill-levels are: top executives, intermediate executives, supervisors and team leaders, highly-skilled professionals, skilled professionals, semi-skilled professionals, non-skilled professionals, and apprentices, interns and trainees.

  12. All marginal effects were computed for the mean value of all continuous variables in the regressors set and for the omitted category of all dummy variables. The estimated count at the mean is 68.6 for an average risk set of 374.2, corresponding to an estimated proportion of fixed-term contracts of 18.3 percent.

  13. Since 1991, the length of the trial period for workers hired with open-ended contracts varies with the complexity and responsibility of the tasks being performed. For top executives it is four times as long as it is for unskilled or semi-skilled workers; for highly skilled workers it is three times as long.

  14. Recall that we are controlling for the skill-structure of the stock, not the flow, of workers.

  15. For the universe of Portuguese firms with at least 100 employees, the voluntary quit rate of workers with an open-ended contract is 5.5 percent. Exits into retirement and workers’ deaths account for 8.3 and 1.6 percent, respectively, of the total number of separations of workers with such contracts.

  16. The firm’s age enters the regression as a qualitative variable with three categories: less than two years (omitted), between two and five and more than five years old. Four intervals were considered for the employees’ age variable: less than 25 (omitted), between 25 and 64 and over 64. Three dummy variables - between 100 and 499 workers (omitted), between 500 and 999 workers, and 1000 workers and more - control for firm size).

  17. Because skill levels are determined by workers’ attributes (education and experience) as well as by their occupation and tenure, which are job-related, we do not include them in the regressor set.

  18. Increasing the share of employees at the very top of the skill structure has a smaller effect on contract conversion than it has at the middle. However, at the top levels - managers and top executives - the proportion of workers admitted with fixed-term contracts is very small.

  19. In these age intervals, employees are less likely to make a transition to all destinations considered. Put differently, these are the workers that face the highest probability of remaining in temporary employment.

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Acknowledgements

We would like to thank David Autor, Olivier Blanchard, Dan Hamermesh, Francis Kramarz, and Juan Dolado for their helpful comments on past versions of this article. The authors also gratefully acknowledge the partial financial support of the Fundação para a Ciência e a Tecnologia under grant PTDC/EGE-ECO/7493/2020. We also thank the Departamento de Estatística do Ministério do Trabalho that kindly allowed us to use the data. CEF.UP is also funded by the Fundação para a Ciência e a Tecnologia (Grant nr. UIDB/04105/2020).

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Portugal, P., Varejão, J. Why do firms use fixed-term contracts?. Port Econ J (2022). https://doi.org/10.1007/s10258-022-00215-0

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Keywords

  • Fixed-term contracts
  • Adjustment costs
  • Labor demand

JEL

  • J23
  • J41