Worker's Limited Liability, Turnover and Employment Contracts

We develop a model of turnover and wages based on the legal limits on workers' liability. A simple two-period model generates differences among firms in entry level wages, and in returns to age and tenure. It predicts that both quits and discharges are negatively correlated with the steepness of the age-earning profile. The discharge prediction is contrary to a job matching or pure human capital model. The predictions of the model are tested on a sample of firms from the Belgian manufacturing sector. We find that 1) the dispersion of pay policy across firms is similar in Belgium and the U.S., 2) this dispersion does not reflect simple rent-sharing or omitted variables, 3) about 8% of workers separate annually with discharges concentrated in the first years, and 4) steeper seniority profiles are associated with lower quit and discharge rates.