A Theory of the Firm with Non-Binding Employment Contracts

Asher Wolinsky

This paper analyzes a dynamic model of a firm in which the wage of each employee is determined in separate bilateral negotiations with the firm. The contractsbetween the firm and its employees are non-binding in the sense that they can be repeatedly renegotiated to adjust to changing situations. The Bargaining power of an employee stems from the threat of quitting that will deprive the firm of this worker's marginal contribution and will put the firm in a weaker position against the remaining workers. This threat is offset to some extent by the replacement opportunities that the firm has, but these are only imperfect in the sense that replacement of quits requires time and effort. The paper characterizes a class of equilibria for this scenario and examines their features. These include a sharp decline of the wage at the firm's target employment level, a mark-up of the wage over the employees' reservation wage and over-employment.

July, 1996
Published in: 
Econometrica 68 (2000), 875-910.