Capital Structure, Wage Bargaining and Employment

We offer a unified framework to analyze the determination of employment, employee effort, wages, profit sharing and capital structure when firms face stochastic revenue shocks. We apply a generalized Nash bargaining solution, which extends the wage bargaining literature by incorporating efficiency wage considerations, profit sharing and capital structure. The profit sharing instrument is demonstrated to have positive effort-augmenting and wage-moderating effects, which exactly offset the negative dilution effect in equilibrium. Leverage is shown to reduce employment and to have a strategic commitment value as a wage-moderating mechanism for firms facing unions in bilateral wage negotiations. Finally, some implications for equilibrium unemployment are discussed.

Introduction: In Europe the unemployment rate has shown a rising trend during the last twenty five years. This has raised the question of how to explain this development.Without going explicitly into that issue, which is still partly unresolved, one should notice that at the moment there are at least three important theoretical approaches to study the determination of unemployment, namely efficiency wage theories, search and matching theories and theories of union bargaining. Here we take the view that these different types of theories are complementary. In Europe various versions of the union bargaining theory have been quite popular. This is natural as in most European countries over three quarters of the workforce have
earned wages that are covered by collective bargaining.

Author: Erkki Koskela,Rune Stenbacka

Source: Research Discussion Papers, Bank of Finland

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