Dynamic labor contracts with temporary layoffs and permanent separations

We study the implications of optimal dynamic contracts in private informati on environments for fluctuations in effort and employment across time and p roductivity states. To this end, we incorporate temporary layoffs and perma nent separations as well as on-the-job effort variations into a dynamic mod el of moral hazard. We consider two different "commitment" environments. In a "full commitment" environment, although the firm can temporarily lay a w orker off, neither party can dissolve the contractual relationship once it has been initiated. On the other hand, in a "limited commitment" environmen t, both parties can dissolve the relationship at the beginning of any perio d in order to pursue an outside option. We use our model to study the implications of optimal contracts: for incent ives, employment histories, layoffs and separations across full information , full commitment and limited commitment settings. We compute solutions to the relevant principal-agent problems, endogenously determining the set off states in which separations occur and the domain of the firm's value funct ion, as well as the value function itself.