Worker Response to a Menu of Implicit Contracts

Abstract

The literature on implicit contracts between workers and firms suggests that workers face a variety of such contracts, allowing each to choose the optimal trade-off between earnings level and earnings stability. This study tests some implications of that theory through an examination of the risk behavior of individual heads of households. The data source is the University of Michigan Panel Study of Income Dynamics, which includes a measure of the worker's taste for risk avoidance. Additionally, several predictions derived from Arrow's postulate of increasing relative risk aversion are examined. The results confirm a tendency of risk-averse individuals to choose jobs offering lower wages and lower financial risk. The results also provide indirect support for Arrow's postulate. The paper's findings suggest that studies of the earnings effects of discrimination may possibly understate those effects, just as studies of the value of a human life may understate that value.