LABOR AND CREDIT CONTRACTS WITH ASYMMETRIC INFORMATION AND BANKRUPTCY

This paper investigates the interaction between a firm's contracts fbr labor and its contracts for credit under asymmetric information and l imited liability, when workers are either always committed to their co ntract or they lack the power to commit ex post because arbitrage oppo rtunities are available to them. The analysis contains two main result s: First, contrary to the perceptions of the limited liability literat ure, where limited liability is thought of causing both underemploymen t and income underinsurance, limited liability is in fact shown to onl y cause underemployment. Existence of outside sources of credit elimin ates the underinsurance side of the inefficiency, but can not eliminat e underemployment. Second, the factor that does cause underinsurance i s the existence of ex post arbitrage opportunities for the worker. Wor ker mobility leads to underinsurance regardless of whether limited lia bility is binding or not and even if outside sources of credit exist. Thus, underemployment stems from limited liability, and underinsurance stems from worker mobility.