Elsevier

Economics Letters

Volume 118, Issue 1, January 2013, Pages 84-86
Economics Letters

Labour market signalling and unemployment duration: An empirical analysis using employer–employee data

https://doi.org/10.1016/j.econlet.2012.09.032Get rights and content

Abstract

We test the signalling hypothesis using detailed flow-based employer–employee data from Denmark. Our main findings are: the signalling value is proportional to the proportion of employees dismissed from the workplace and the signal is uniform across occupation groups.

Highlights

► Testing the signalling hypothesis using heterogeneity in displacement reasons. ► We find strong support for the signalling hypothesis. ► The signalling value is proportional to the proportion of employees dismissed. ► The strength of the signal is uniform across occupation groups.

Introduction

In recent years, numerous studies have investigated the duration of unemployment. These studies most often begin when a worker is observed in unemployment and end when the worker leaves unemployment. Hence, the possibility that factors related to the previous employment relation may influence the duration of unemployment is in general not considered.1

In the seminal work by Gibbons and Katz (1991), the reason for displacement from the previous job is argued to be an important signal which influences the subsequent labour market outcome. The Gibbons–Katz signalling hypothesis is based on asymmetric information arguments where the worker’s ability can be learned only after the employment match is formed. The firm’s learning process and the presence of minimum performance standards have the implication that “outside” firms infer that laid-off workers will be of low ability and hence condition their hiring decision on the revealed information. Given that company closures are exogenous (in the sense of not being caused by their own workforce), no such inference can be made when displacement is due to workplace closures. Hence, prospective employers can use the information that a worker was displaced by a workplace closure (as opposed to an individual layoff) as a positive signal of ability. Consequently, these workers should have shorter unemployment spells.

In this paper we use Danish register data to test the signalling hypothesis. Specifically, we test if workers who lose their jobs as a result of workplace closures have shorter unemployment durations than individuals displaced for other reasons, controlling for a comprehensive set of individual-specific explanatory variables. Further, we extend the analysis by investigating if the signalling hypothesis can be applied to situations that are less extreme than workplace closures such as severe downsizing. Finally, we investigate if the strength of the signal varies across employee subgroups.

Our findings strongly support the signalling hypothesis and provide the novel result that the signalling value is proportional to the proportion of the workforce that is displaced. We also find that the strength of the signalling effect is uniform across occupation groups in Denmark. This result should be seen in the light that Doiron (1995) argues that the signalling effect may vary across different types of workers due to the degree of asymmetric information associated with the profession and shows that the signalling effect is absent for blue-collar workers in Canada. A similar finding is made for the US in Gibbons and Katz (1991).

The paper is organised as follows. In the next section, we describe the institutional settings in Denmark and the data used in the analysis. Results are presented in Section 3. Finally, Section 4 summarises and concludes.

Section snippets

Institutional settings

The Danish labour market is characterised by a high degree of unionisation and instant access to unemployment benefits when a worker is laid off. For workers who have paid unemployment insurance for at least one year and worked at least 52 weeks in the three years prior to losing their jobs, the unemployment insurance (UI) benefit is 90% of the monthly salary up to a maximum. This implies that low-wage workers receive UI benefits very close to their former salary, while high-wage workers have

Empirical results

In this section, we test the signalling hypothesis. We first investigate if employees displaced due to workplace closure have shorter spells of unemployment than employees displaced for other reasons. We then consider more detailed signals including severe downsizing. Finally, we interact the signals with covariates to assess signal heterogeneity.

In Table 1 we present the results from competing risk models.3

Conclusion

In this paper, we have tested the signalling hypothesis developed by Gibbons and Katz (1991). We do this by investigating how reason for displacements can be used as signals to prospective employers and by that affect the employees’ reemployment perspectives. We have applied a competing risk model where exits from unemployment are into employment or inactivity. The main result is that workers who have lost their jobs because of workplace closures get a new job faster than workers who are

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