Commitment and discretion in contracts: theory and evidence from retirement plans*

We consider a firm's problem of incentivizing its workforce through relational contracts, when workers effectively face a shorter time horizon due to possible separation shocks. Commitment issues then generate a trade-off between efficiency and distribution, which affects both performance and profits. Profits under relational contracting can exceed those under formal contracting, despite lower performance, when discounting is moderate, firm bargaining power is weak, and shocks are likely. Using a matched employer–retirement plan dataset, and interpreting discretionary profit-sharing plans and employee stock ownership plans as relational and formal contracting, respectively, we find some support for our predictions.     

A model of social insurance with variable retirement

Models are studied, in which ability to supply labour is affected by a random variable (health) not observable by government. When ill-health strikes, the consumer must retire, but he may choose to retire in any case. Optimal social insurance policies are found for one-period, two- period, and continuous-time models. It is found that, under plausible conditions, at the optimums consumers are indifferent whether to work or not, but do work when able. Insurance contributions decrease with age, and insurance benefits increase with age of retirement. It is desirable to prevent private saving. Some comments on the U.S. Social Security system are added.     

Quasi-hyperbolic preferences and retirement: A comment

Diamond and Koszegi [Diamond, P. and Koszegi, B. (2003), “Quasi-Hyperbolic Preferences and Retirement,” Journal of Public Economics, 87: 1839–1972] have argued that quasi-hyperbolic discounting can cause dynamic inconsistency in planning when to retire as well as in consumption plans. This comment shows that in a simple model with such preferences, retirement plans are never time-inconsistent, as these same preferences keep savings too low for individuals to ever be able to afford unplanned early retirement. Although only a simple example is presented here to demonstrate the point, this insight suggests the application of ordiamond03's framework should be reconsidered. The model presented needs to be extended to find robust general conclusions.     

Taxation of early retirement windows and delaying retirement: The French experience

This paper investigates the effect of the 2003 French pension reform on hiring, firing and employment rates among older workers. This reform increased the mandatory retirement age and simultaneously it set a tax levied on early retirement windows paid by firms to their older workers, to encourage them to leave their job early. We use a matching model with endogenous job destruction extended to account for a mandatory retirement age and we calibrate the model with data drawn from the French Labor Force Surveys for the years 2002 and 2003. We show that in the case of a high tax rate, delaying retirement raises job separation rates, which partially offsets its positive effect on job finding rates. Consequently, the combination of an increase in the retirement age and a taxation on early retirement windows may have negative effects on the employment rate among older workers.     

Quasi-hyperbolic discounting and retirement

Some people have self-control problems regularly. This paper adds endogenous retirement to Laibson’s quasi-hyperbolic discounting savings model [Quarterly Journal of Economics 112 (1997) 443–477]. Earlier selves think that the deciding self tends to retire too early and may save less to induce later retirement. Still earlier selves may think the pre-retirement self does this too much, saving more to induce early retirement. The consumption pattern may be different from that with exponential discounting. Other observational non-equivalence includes the impact of changing mandatory retirement rules or work incentives on savings and a possibly negative marginal propensity to consume out of increased future earnings. Naive agents are briefly considered.     

Delaying retirement in Spain

We study the reform of the Spanish public pension system in a multiperiod, general equilibrium, overlapping generations model economy populated by heterogeneous households. Our households differ in their place of birth, in their age, in their education and, endogenously, in their employment status, in their wealth, and in their pension entitlements. They receive a stochastic endowment of efficiency labor units each period. And they face a disability risk and a survival risk. They understand the link between the payroll taxes that they pay and the public pensions that they receive. And they decide how much to consume and to work, and when to retire from the labor force. We calibrate this economy to Spanish data, and we use it to study the consequences of delaying three years the statutory retirement ages in 2010. We find this reform is sufficient to solve the sustainability problems that plague the current Spanish public pension system. Our model economy predicts that under the current rules, the pension system fund will run out in 2028 and in the reformed economy it will last until 2050. We also find that it is moderately expansionary, and that it improves social welfare from the year 2015 onwards. We conclude that policymakers should seriously consider delaying the statutory retirement ages in Spain sometime in the near future.     

Equilibrium unemployment and retirement

We first propose some new empirical evidence on the fact that the labor market conditions matter for the retirement decision at the individual level: we investigate whether unemployed workers retire before employed workers, other things being equal. Our main objective in this paper is then to propose an equilibrium unemployment approach to retirement decisions that allows us to derive the positive and normative features of retirement decisions when search and matching frictions are considered. Two main conclusions emerge: the retirement decision of unemployed workers depends on the labor-market frictions whereas that of employed workers does not; the existence of search externalities makes the retirement age of unemployed workers intrinsically suboptimal. Considering Social Security policy issues, we show that the complete elimination of the implicit tax on continued activity is not necessarily welfare-optimizing in a second best world where the labor market equilibrium suffers from distortions.     

The looming retirement crisis

A retirement crisis looms in the United States due to a number of recent and emerging trends that affect government retirement programs, employer- and union-sponsored retirement benefits and personal savings arrangements. The crisis can be averted, but only with well-thought-out action on a number of issues, particularly Social Security and Medicare reform.     

Capital utilization and retirement

This empirical analysis assesses the determinants of firms’ capital retirement. Particular attention is paid to the impact of the business cycle and the capital usage intensity. Compared to previous studies, we directly control for the capital utilization and disentangle the short-run mechanisms from the long-run ones. The analysis is carried out with an original and large firm-level dataset. The main results of the analysis may be summarized as follows: (i) the retirement rate increases during slowdowns and decreases during booms. This corresponds to a countercyclical capital retirement; (ii) the capital retirement rate increases with the capital usage intensity in the long run. This corresponds to a wear and tear effect, which is small compared to the countercyclical one; (iii) the capital retirement rate increases with the average age of capital; (iv) the profit rate and the wage cost per capita do not have a significant impact on the retirement rate.     

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The retirement consumption puzzle revisited: Evidence from the mandatory retirement policy in China

Using data from China's Urban Household Survey and exploiting China's mandatory retirement policy, we use the regression discontinuity approach to estimate the impact of retirement on household expenditures. Retirement reduces total non-durable expenditures by 19%. Among the categories of non-durable expenditures, retirement reduces work-related expenditures and expenditures on food consumed at home but has an insignificant effect on expenditures on entertainment. After excluding these three components, retirement does not have an effect on the remaining non-durable expenditures. It suggests that the retirement consumption puzzle might not be a puzzle if an extended life-cycle model with home production is considered.     

Precautionary retirement and precautionary saving

The paper analyzes the lifetime utility maximization problem of an agent who chooses her saving and timing of retirement in the presence of labor income risk in a simple setting where a pure redistributive pension scheme is in place. In this context, a precautionary motive for retirement, which pushes old workers to replace an uncertain labor income with certain pension payments, and to retire early is identified. The conditions for precautionary retirement and saving to arise are then characterized and interpreted in two settings. In the first setting, utility only depends on income, and a sufficiently low level of absolute prudence is necessary for precautionary retirement. A sufficiently high level is necessary however for precautionary saving, which can coexist with precautionary retirement only for intermediate values of absolute prudence. In the second setting, agent utility also depends on leisure, and three conditions allow the precautionary motive for retirement and saving to jointly operate: prudence, an index of absolute prudence sufficiently low and cross-prudence in leisure.     

Analyses of retirement benefits with options

This study applies the contingent claim approach to evaluate retirement benefits with the options of choosing the maximum defined benefit and defined contribution pension plans. A least-squares Monte Carlo simulation values complex retirement benefits that feature the properties of multiple variables, early exercise, stochastic interest rates, and several embedded options. Furthermore, this study examines the impacts of different forms of early decrements of the value of retirement benefits with options.     

The trajectory of wealth in retirement

In this paper, we develop a measure of household resources that converts total financial and non-financial assets, plus annuity-like assets (mainly, Social Security and defined-benefit pensions) into an expected annual amount of wealth per person in retirement. We use this measure, which we call “annualized comprehensive wealth,” to investigate spend-down behavior among a panel of older households in the Health and Retirement Study (HRS) from 1998 to 2006. Our analysis indicates that for most retired households, comprehensive wealth balances decline much more slowly than their remaining life expectancies, so that the predominate trend is for real annualized wealth to rise significantly with age over the course of retirement. Comparing the estimated age profiles for annualized wealth with profiles simulated from several different life-cycle models, we find that a model that takes into account uncertain longevity, random medical expenses, and intended bequests lines up best with the broad patterns of rising annualized wealth in the HRS.     

Time inconsistency and retirement planning

We quantify the welfare gains from better retirement planning using a model in which retirement planning is time inconsistent. A modest increase in a household’s planning horizon by just a few years generates large aggregate and individual welfare gains.