Institute for Research on Labor and Employment

This paper examines labor contracts as a form of insurance contracts. It assumes that workers are risk averse with the time perspective (or planning period) of a worker combining a period of T distinct spells t, with length of a spell being the same for all workers (a spell might be a year for example). Workers are assumed to differ only according to their time perspective: For example some workers planning period may consist of only one spell (T=1), while for others it may be three spells (T=3). The analysis starts with the assumption that workers are hired on a neoclassical spot contract at the beginning of each spell . Then it shows that, if workers objective is to maximize the sum of their incomes over all spells in their planing period, income risk that derives from the uncertainty of employment caused by stochastical business cycles in each spell will be more threatening to workers with a shorter time perspective T than to those with a longer time perspective. Therefore, if a firm offers an institutionalized contract that bears no employment risk and covers the worker´s individual planning period T, the worker´s willingness to pay risk premiums by wage concessions decreases, the longer is his planning period. On this pure risk theoretical point of view, the firm will prefer workers with short individual planning periods in order to maximize their insurance premiums. Thus this paper contradicts the common argument that long term contracts are advantageous to firms.