Scandinavian Working Papers in Economics

Working Papers,
University of Aarhus, Aarhus School of Business, Department of Economics

No 08-1: Returns to Tenure or Seniority?

Sebastian Buhai (), Miguel Portela (), Coen Teulings () and Aico van Vuuren ()
Additional contact information
Sebastian Buhai: Department of Economics, Aarhus School of Business, Postal: The Aarhus School of Business, Prismet, Silkeborgvej 2, DK 8000 Aarhus C, Denmark
Miguel Portela: University of Minho, Postal: Portugal
Coen Teulings: CPB Netherlands Bureau for Economic Analysis, Postal: Univ. of Amsterdam and Tinbergen Institute
Aico van Vuuren: Free University, Postal: Amsterdam, and Tinbergen Institute

Abstract: This study documents two empirical regularities, using data for Denmark and Portugal. First, workers who are hired last, are the first to leave the firm (Last In, First Out; LIFO). Second, workers' wages rise with seniority (= a worker's tenure relative to the tenure of her colleagues). We seek to explain these regularities by developing a dynamic model of the firm with stochastic product demand and hiring cost (= irreversible specific investments). There is wage bargaining between a worker and its firm. Separations (quits or layoffs) obey the LIFO rule and bargaining is efficient (a zero surplus at the moment of separation). The LIFO rule provides a stronger bargaining position for senior workers, leading to a return to seniority in wages. Efficiency in hiring requires the workers’bargaining power to be in line with their share in the cost of specific investment. Then, the LIFO rule is a way to protect their property right on the specific investment. We consider the e¤ects of Employment Protection Legislation and risk aversion.

Keywords: irreversible investment; efficient bargaining; seniority; LIFO

JEL-codes: J31; J41; J63

51 pages, January 18, 2008

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