Downsizing with labor sharing and collusion

In this paper we develop a model with adverse selection on the productive efficiency of workers in the private sector to analyze the downsizing problem in a public enterprise. Workers are distinguished by an inside productivity factor. Our result shows that reallocation of labor in the optimal downsizing mechanism depends on the comparative advantage of workers in public versus private production and on the size of asymmetric information. In particular, if information asymmetry is small, random downsizing mechanisms may become optimal. We also show that collusion between workers and the manager in charge of downsizing may induce more screening than in the absence of collusion if information asymmetry is large enough. Finally, we study how risk aversion of workers affects the optimal downsizing mechanism. (C) 2003 Elsevier B.V. All rights reserved.