||This paper considers a two-period optimal contracting
model in which …rms make new hires in the second period subject to the
constraint that they cannot pay discriminate either against or in favour
of the new hires. Under an assumption on the information available to
workers, it is shown that wages are less ‡exible than needed for e¢cient
employment levels, with the result that too few hires are made in bad
states of the world. Unemployment is involuntary. In an extension to
the model, there may also be involuntary and excessive layo¤s in some
states of the world.
Keywords: Implicit contract theory, wage rigidity, involuntary unemployment.