Plant Closings, Labor Demand and the Value of the Firm

This study postulates an internal labor market in which workers accumulate firm-specific human capital that raises the value of the firm and insulates it to some extent from the vagaries of product demand that might result in its closing. Negative product-market shocks reduce wage growth and increase the probability of the firm closing. The model also predicts a U-shaped relation between the probability of the plant closing and the length of a worker's tenure, a proxy for firm-specific human investment. PSID data for 1977 through 1981 are used to produce weighted-probit estimates of the parameters of an equation describing the probability of displacement. The results support most of the predictions of the model, but similarly specified equations describing the probability of permanent layoff indicate that a theory of plant closings must differ from that of layoffs. The parameter estimates are used to infer an analogue to the firm's elasticity of demand for labor and to deduce the wage reduction necessary to avoid an increase in the probability of a plant closing when a negative demand shock occurs.