Financing Constraints and Fixed-Term Employment Contracts

The aim of this paper is to identify the effect of financing constraints on the employment decisions of firms. We present a theoretical model that determines the optimal use of fixed term and permanent contracts in the presence of financing constraints. We then estimate the effect of financing constraints on the dynamics of fixed-term employment contracts versus permanent employment contracts for a sample of Italian manufacturing firms. The results are consistent with the model and show that financially constrained firms tend to use a larger proportion of fixed term contracts, and that the relative volatility of fixed term employment versus permanent employment is higher among them. As a consequence, the volatility of total employment is also significantly higher for financially constrained firms than for financially unconstrained ones. ∗The authors thank Maria Guadalupe, Maia Guell, Barbara Petrongolo and Ernesto Villanueva for their valuable comments and suggestions. All errors are, of course, the authors own responsibility. †[email protected] and [email protected], Pompeu Fabra University, Department of Economics, Calle Ramon Trias Fargas 25-27, 08005, Barcelona, Spain. 1 Barcelona Economics WP no 266