Delays in Labor Contract Renewals: Theory and Evidence

The duration of contemporary labor contracts is more flexible than the rigid wording of the contracts seems to indicate. In particular, it is common practice that the terms of the old contract are automatically extended during the often protracted holdout period between the expiration date of the old contract and the signing of the new contract. The purpose of this paper is to examine how the delay depends on aggregate economic variables. Our approach emphasizes the importance of macroeconomic factors such as the uncertainty and trends in the value of money and the aggregate productivity. By delaying a new contract, more information about the price level becomes available so that the contractual real wage can more accurately reflect the worker's marginal product. This reduces the risk which benefits the risk-averse worker and therefore tends to increase the delay in the contract renewal. On the other hand, as the contract renewal is delayed, more of the uncertainty about the worker's productivity is resolved, which increases the risk for the worker and thus tends to reduce the delay in the contract renewal. The model also predicts the effects of unemployment and elections, as well as the differential impacts of the various variables in the private and public sectors. We test the model with data from Israeli labor contracts and the findings generally support the theoretical model.