DP4031 Job Protection Laws and Agency Problems Under Asymmetric Information

Author(s): Patrick W. Schmitz
Publication Date: December 2004
Keyword(s): employment protection, job security, labour market rigidities
JEL(s): D82, E24, J65, K31
Programme Areas: Labour Economics
Link to this Page: www.cepr.org/active/publications/discussion_papers/dp.php?dpno=4031

Under symmetric information, a job protection law that says that a principal who has hired an agent today must also employ them tomorrow can only reduce the two parties’ total surplus. The law restricts the principal’s possibilities to maximize their profit, which equals the total surplus, because they leave no rent to the agent. However, under asymmetric information, a principal must leave a rent to the agent, and hence profit maximization is no longer equivalent to surplus maximization. Therefore, a job protection law can increase the expected total surplus by restricting the principal’s possibilities to inefficiently reduce the agent’s rent.