Employment Protection Legislation (EPL) is a set of laws which rule the dismissal of employees. Many papers have studied the effect of changes in EPL on employment and job flows. This paper studies the effect of EPL on the distribution of wages.
The firing cost consists of a transfer from the employer to the employee (severance payment) and a tax (e.g. the trial costs). While the tax part of the firing cost cannot be part of the negotiations between employers and employees, it is known since the work of Lazear (1990) that the transfer part of EPL can be undone by changes in wages in a flexible wage framework. The firm reduces the entry wage of a worker by an amount equal to the expected present value of the future severance payment and leaves the cumulative wage bill unchanged. Thus the theory predicts a wage decrease for new entrants. Unlike new entrants, insiders should gain from the introduction of stricter EPL, in fact in a bargaining framework a higher EPL improves the bargaining power of the insiders while worsening the outside option of the firm.
Until 1998, there were two main players in the Israeli credit card industry: Isracard, which was established in 1975 and is 100% owned by the largest bank in Israel, Bank Hapoalim, and CAL which was established in 1978 and was jointly owned at the time by the second largest bank in Israel, Bank Leumi (65%), and the third largest bank, Israel Discount Bank (35%). Isracard issued its own brand of credit card, called Isracard, for domestic use in Israel, and Mastercard and American express card for use in Israel and abroad, while CAL issued Visa cards, under the brand name Visa CAL, and Diners Club cards. Apart from the three largest banks, there are two additional large banks in Israel, United Mizrahi Bank and First International Bank of Israel (FIBI). Both banks, as well as some other smaller banks, were authorized to issue Visa CAL cards to their clients, although Visa CAL was the sole acquirer of Visa card transactions.
Since 1998, the Israeli credit card industry was transformed from a duopoly with two credit card companies, which offer proprietary cards, to a triopoly with two large systems, Visa and Mastercard. The changes began when FIBI established a new credit card company, Alpha card, together with a large investment group (Aurek). Alpha Card started operating in July 1998 and offered its own brand of Visa card, called Visa Alpha. Despite reaching a market share of around 16% in the Visa market by the end of 1999, the new company incurred large losses and decided to exit the market in 2000. Meanwhile, the supervisor of banks and the director of the Israeli Antitrust Authority (IAA) ordered Bank Leumi and the Israel Discount Bank (IDB) to dissolve their joint ownership of CAL, following Amendment No. 11 of the Israeli Bank Law (Licensing) which states that banks cannot jointly own auxiliary corporations. Following this order, IDB bought Bank Leumi’s share in CAL in February 2000 and shortly afterwards, brought new partners to CAL, including FIBI which acquired 20% of the shares of CAL. Currently, IDB’s ownership share in CAL is 51%. The remaining 29% are held by a large investment group, the Fishman group (24%), and an insurance company, Harel Hamishmar (5%). Bank Leumi in turn established its own fully owned credit card company, Leumi Card, and bought Alpha card’s operational infrastructure. Alpha card’s clients were sold to CAL. Leumi Card began offering its brand of Visa cards, Visa Leumi, in 2001. Following these changes, there are currently three credit card companies in the Israeli market: Isracard, CAL, and Leumi Card.
In this paper we provide new evidence that relates asset prices, consumption volatility and expected growth. In particular, we show that economic uncertainty (that is, consumption volatility) sharply predicts and is predicted by asset valuation ratios. Our evidence shows that a rise in economic uncertainty leads to a fall in asset prices, and that high valuation ratios predict low subsequent economic uncertainty. In addition, we show that there is a strong positive relation between aggregate earnings growth and asset prices. In all, our evidence suggests that fluctuations in economic uncertainty and expected growth are potentially important channels for interpreting asset markets and the variation in asset prices.
Why is this evidence important? First, this empirical evidence highlights an often discussed but not verified view that aggregate economic uncertainty (i.e., real aggregate consumption volatility) has sizable effects on asset valuations and that financial markets dislike economic uncertainty. Our empirical work for the U.S. and foreign economies suggests that the effects of fluctuating economic uncertainty on asset valuations are sizable. Second, the evidence regarding growth rates suggests that fluctuations in expected growth directly affect asset valuations and information regarding future expected growth is encoded in current asset valuations. Our overall evidence regarding economic uncertainty and expected growth suggests that a plausible interpretation of asset markets is based on these economic fundamentals. A rise in economic uncertainty increases expected returns and leads to a fall in asset valuations. A rise in expected growth, on the other hand leads to a rise in asset valuations. Both these effects can be interpreted from the perspective of general equilibrium models (see for example, Bansal and Yaron (2004)).
