Employment Protection Legislation and Adverse Selection at the Labor Market Entry

This paper investigates how the labor market institutions that characterize most of the European countries affect the integration process of younger workers on the labor market. We argue that young workers have private information about their abilities when entering the labor market. However, this information asymmetry does not prevail as the production process reveals the worker’s type. Adverse selection distorts hiring practices at the labor market entry. We develop a dynamic principal-agent model and first derive the optimal menu of labor contracts employers can use as a self-selection mechanism. Firms offer an increasing wage to high-productive workers while a flatter wage profile to low-productive workers. Our theory suggests that a high level of firing costs as well as the presence of a minimum wage prevent employers from offering separating contracts to new entrants and thus contribute to the time-consuming integration process of youth. Finally, we provide numerical exercises to illustrate our theoretical findings on the optimal wage profile and to assess the consequences for employment opportunities. A.Bucher: GAINS-TEPP, Université du Maine, Faculté de Droit et de Sciences Économiques, Avenue Olivier Messiaen, 72085 Le Mans Cedex 9, France +33(0)2 4383 3134 e-mail: [email protected] S.Ménard: GAINS-TEPP, Université du Maine, Faculté de Droit et de Sciences Économiques, Avenue Olivier Messiaen, 72085 Le Mans Cedex 9, France +33(0)2 4383 2797 e-mail: [email protected] 1 ha ls hs -0 08 12 09 9, v er si on 1 11 A pr 2 01 3