When little is known about the future market conditions, offering an employment contract that regulates working conditions for many periods can be dangerous. If market wages drastically decline, one may hire labor more cheaply. Furthermore, an employee may turn out less reliable than expected. Such risks are by no means farfetched. Rather, they relate to crucial aspects of long-term employment. (1) So why is long-term employment still predominant and short-term employment, for example in the form of rented labor, rare, albeit increasing (see Alewell et al. 2007)? An explanation might be the increasing institutional flexibility regarding wage adjustments. Institutional downward flexibility is usually not legally codified but often a consequence of court rulings and thereby based on social norms (2) (see, for instance, Bewley 1995).
In our paper, we want to investigate whether more flexibility in wage adjustment (from none to full flexibility) increases the duration of accepted employment contracts. Our first hypothesis (Hypothesis A) which we wish to test experimentally is that contract duration depends on contract flexibility.
One obvious argument for long-term employment is that offering a short-term contract reveals distrust in the newly hired worker and encourages shirking. But what is wrong with long-term employment resulting from both partners, employer, and employee, repeatedly and mutually opting for rematching? Another reason for long-term employment could be that, in the long run, it allows the interacting parties more easily to overcome efficiency losses due to opportunistic behavior. In our experimental scenario, regulations prevent efficient employment contracts when workers react opportunistically. But do long-term employees care more for efficiency, and therefore invest more than optimal efforts?
Deregulation (3) has been the major policy recommendation for nearly all developed market economies. For the most part, the effects of (de)regulation are predicted by rational choice analyses of labor markets. An interesting exception that takes into account the empirical evidence from behavioral labor economics (Fehr, Gotte, and Zehnder 2009) is the analysis of Agell (1999), in whose tradition we want to provide a behaviorally informed discussion of (de)regulation. Rather than doing this by field data our empirical approach is an experimental one. Our earlier (experimental) findings (Berninghaus, Bleich, and Giath 2008) question the idea that labor market efficiency is higher in deregulated markets. To determine more systematically whether the usual intuition that wage rigidities undermine efficiency is correct, or whether our earlier results are more reliable, we analyze more thoroughly the interdependency of wage flexibility and employment duration. Our second hypothesis claims that long-term contracts are substituted by renewable contracts when contracts become more inflexible (Hypothesis B). Unlike in our previous study, where we varied only the flexibility of fixed wages, in this study, piece rates may also be adapted periodically.
In the experiment of Brown, Falk, and Fehr (2004), where work contracts last for only one period, long-term relationships between employers and employees can only be established if the employer offers a new contract to the same employee in each period. We too allow for voluntary renewal of contracts at the end of each period, but also the possibility of offering contracts which extend for more than one period. Our study is more systematic than previous ones because we do not just compare less with more labor flexibility but distinguish five flexibility treatments which can be at least partially ordered from less to more flexibility. For any kind of monotonicity hypothesis, this can be viewed as a real stress test.
Note that already the one-off interaction of our basic labor market scenario allows for reciprocity (4) since employees choose effort after accepting a more or less favorable employment contract. …