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Employment Security: A Comparative Institutional
Kenneth G. Dau-Schmidt
Indiana University Maurer School of Law, email@example.com
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Dau-Schmidt, Kenneth G., "Employment Security: A Comparative Institutional Debate" (1996). Articles by Maurer Faculty. Paper 593.
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Employment Security: A Comparative Institutional
Kenneth G. Dau-Schnidt*
The debate at this Symposium concerning what legal doctrine should
govern questions of employment security mirrors the larger academic debate on this subject in its diversity of opinions and arguments.' Supporters
and detractors of the employment-at-will doctrine have presented arguments
concerning the number of unjust discharges,2 the preferences of employers
and employees with respect to job security,3 the relative bargaining power
and information available to employers and employees, 4 the effect of the
employment-at-will doctrine on the enforcement of other statutes such as6
Title VII,' the efficacy of collateral torts in wrongful discharge litigation,
employer opportunism over the employee life-cycle, 7 and the external costs
of discharges in violation of public policy.8
Professor of Law, Indiana University-Bloomington, on leave from the University of Wisconsin.
B.A. 1978, University of Wisconsin; M.A., J.D. 1981, Ph.D. (Economics) 1984, University of
Michigan. I would like to thank Sam Issacharoff, Jack Getman, and the editors of the Texas Law
Review for inviting me to participate in the Symposium and write this comment. I would also like to
thank the other participants in the Symposium for the knowledgeable and stimulating discussion that
inspired these comments.
1. A nonexhaustive bibliography of the larger academic debate includes: PAUL C. WEILER,
GOVERNING THE WORKPLACE: THE FUTURE OF LABOR AND EMPLOYMENT LAW (1990); Richard A.
Epstein, In Defense of the Contract at Will, 51 U. CHI. L. REV. 947 (1984); Andrew P. Morriss,
Exploding Myths:An EmpiricalandEconomic Reassessment of the Rise of EmploymentAt-Will, 59 Mo.
L. REV. 679 (1994); Cornelius I. Peck, Unjust Dischargesfrom Employment: A Necessary Change in
the Law, 40 OHIO ST. L.J. 1 (1979); Theodore J. St. Antoine, A Seed Germinates: Unjust Discharge
Reform Heads TowardFull Flower, 67 NEB. L. REV. 56 (1988); Stewart J. Schwab, Life-Cycle Justice:
Accommodating Just Cause and Employment at Will, 92 MICE. L. REV. 8 (1993); Clyde W. Summers,
IndividualProtectionAgainst Unjust Dismissal:Time for a Statute, 62 VA. L. REv. 481 (1976); and
J. Hoult Verkerke, An EmpiricalPerspective on Indefinite Term Employment Contracts:Resolving the
Just CauseDebate, 1995 WIs. L. REV. 837.
2. Andrew P. Morriss, Bad Data, Bad Economics, and Bad Policy: Time to Fire Wrongful
DischargeLaw, 74 TEX. L. REV. 1901, 1905-14 (1996).
3. Verkerke, supra note 1, at 841-43.
4. Samuel Issacharoff, Contractingfor Employment: The Limited Return of the Common Law, 74
TEX. L. REV. 1783, 1792-95 (1996).
5. Cynthia L. Estlund, Wrongful Discharge Protections in an At-Will World, 74 TEX. L. REV.
1655, 1678-82 (1996).
6. Mark P. Gergen, A Grudging Defense of the Role of the Collateral Torts in Wrongful
Termination Litigation, 74 TEX. L. REV. 1693 (1996).
7. Morriss, supra note 2, at 1919; Schwab, supra note 1, at 39, 38-51; Verkerke, supra note 1,
at 861-63. For the theory of opportunistic use of the life-cycle, see infra note 19.
8. Stewart J. Schwab, Wrongful DischargeLaw and the Searchfor Third-Party Effects, 74 TEx.
L. REV. 1943 (1996).
Texas Law Review
Although the arguments put forth in this Symposium and in the larger
academic debate are diverse, I maintain that they all really address one
question of comparative institutional analysis: 9 Which institutionindividual bargaining, collective bargaining, the courts, or legislative and
administrative regulation-can most efficiently accommodate employers'
and employees' preferences concerning employment security? As formulated in this Symposium, the debate over this question has focused primarily on the possible failures of individual bargaining to accommodate these
divergent preferences and only secondarily on the possible deficiencies of
the alternative institutions-these later deficiencies being raised largely as
a rear-guard action by the defenders of individual bargaining.1" This
focus on individual bargaining and its possible virtues and failures seems
appropriate given that, despite a growing list of common-law and statutory
exceptions to the notion of freedom of contract in employment law,
individual bargaining remains by far the dominant institution for
determining employment security rights in this country.1
comparative institutional analysis, however, one must examine the
advantages and disadvantages of each alternative institution for resolving
the conflict over employment security before one can make public policy
I will return to this question of the possible
advantages and disadvantages of the alternative institutions put forth in the
employment security debate toward the end of this comment. 13
Morriss and Verkerke are right to extol the virtues of individual
bargaining.' 4 When it works, it provides individualized solutions to
problems by balancing the divergent preferences of the affected parties
9. For the definitive treatise on comparative institutional analysis, see NEIL K. KOMESAR,
IMPERFECr ALTERNATIVES: CHOOSING INSTITUTIONs IN LAW, ECONOMICS, AND PUBLIC POLICY
10. See, e.g., Morriss, supra note 2, at 1933-36 (arguing that the regulation of labor markets
through institutions would be ineffectual or counterproductive). Professors Estlund and Issacharoff also
explicitly discuss the efficacy of other institutions in dealing with the problem of employment security.
See infra notes 22-24, 45-47 and accompanying text.
11. Kenneth G. Dau-Schmidt, Meeting theDemandsof Workers into the Twenty-First Century:The
FutureofLabor andEmployment Law, 68 IND. L.J. 685, 691 (1993) (stating that individual bargaining
dominates collective bargaining and regulation in the resolution of employer and employee conflict over
the terms of employment); see also Terry A. O'Neil, Employees' Duty of Loyalty and the Corporate
ConstituencyDebate, 25 CONN. L. REV. 681, 691 (1993) (stating that the unions' ability to negotiate
protective contracts is "useless to most employees because over eighty percent of the workforce is
12. See KOMESAR, supranote 9, at 6 (arguing that "the correct question" is the comparative ability
of institutions to deal with a specific issue).
13. See infra text accompanying notes 41-48.
14. See Morriss, supra note 2, at 1923 ("[D]ifferent employees have different preferences about
job security. Legal rules which apply one-size-fits-all standards of job security will inevitably
disadvantage some employees."); Verkerke, supra note 1,-at 843 (arguing that empirical data undermine claims of market failure in the employment contract context).
according to their willingness to pay. t" On the problem of employment
security, absent some failure of the bargaining process, employees could
use individual bargaining to obtain all the contractual employment security
they desire as long as the costs of those contractual protections to the
employer are less than the benefits of those terms to the employees. If
employees did not contract for employment security of some type, it would
be because the cost to the employer of such assurances outweighed their
benefits to the employees and the employees decided they would rather do
without the security and take their portion of the savings in higher wages
and benefits. 6
Unfortunately, participants in this Symposium have identified a
number of plausible ways in which individual bargaining may fail to
accommodate adequately the countervailing costs and benefits of employment security. Schwab and Estlund argue that individual bargaining fails
to account for all the costs of employer discretion in firing because
sometimes discharges impose costs on parties other than those engaged in
the negotiations."i Schwab persuasively offers this externalization-of-costs
argument as a rationale for the tort of wrongful discharge in violation of
public policy.'8 Schwab has also argued elsewhere that, because of
transaction costs in negotiations and enforcement, individual bargaining
fails to specify long-term implicit contracts that would provide the
employee with protection from opportunistic discharge by the employer
over the employee's life-cycle.' 9 Schwab enjoys some success in linking
15. See RIcHARD A. POSNER, ECONOMIC ANALYSIS OF LAW 11 (4th ed. 1992) ("By a process of
voluntary exchange, resources are shifted to those uses in which the value to the customer, as measured
by willingness to pay, is highest.").
16. See Morriss, supra note 2, at 1902-03 ("[T]he default nature of the at-will rle allows the
heterogeneous class of employees to choose among a diverse set of job characteristics when making
17. See Estlund, supra note 5, at 1664-65 (arguing that the wrongful discharge antidiscrimination
and antiretaliatory doctrines protect the public as a whole by promoting the equality of citizens and
providing incentives for employees to disclose illegal conduct); Schwab, supra note 8, at 1951-52
(noting that at-will employment does not adequately deter employers from requiring that their employees engage in activities like lying under oath, serving drinks to the drunk, or refusing jury duty).
18. Schwab, supra note 8, at 1950-52. For cases examining the public policy wrongful discharge
tort, see, for example, White v. American Airlines, Inc., 915 F.2d 1414, 1421 (10th Cir. 1990)
(ordering a jury instruction that would allow the plaintiff to recover in his wrongful discharge suit if
it was found that the termination was "significantly motivated by the [plaintiffs] refusal to commit
perjury" because of the strong public interest in truthful testimony); Nees v. Hocks, 536 P.2d 512, 516
(Or. 1975) (holding that the tort of wrongful discharge for violation of public policy could be asserted
by an employee who alleged that she was fired for performing jury duty because of the important
community interest in the jury system).
19. Schwab, supra note 1, at 52-54. Under the life-cycle theory, workers are paid less than their
productivity justifies early in their tenure with the firm, and more than their productivity justifies late
in their tenure. Id. at 14-15. This practice allows employees to invest in job-specific human capital
and prevents shirking because employees will not want to be discharged before they obtain the high
wages of their late tenure. Id. at 17. Unfortunately, this life-cycle of wages and productivity gives
Texas Law Review
his economic arguments with the implied covenant of good faith and fair
dealing, 20 although Verkerke challenges his reading of the cases. 1
Issacharoff accepts Schwab's life-cycle arguments, and also argues that
employees suffer in individual bargaining from an asymmetry of information and bargaining power between employees and employers. '
the basis of the asymmetries in individual bargaining, Issacharoff argues
for "information-forcing" defaults in employment contract law that would
effectively require employers to raise the question of employment security
in individual negotiations and make clear the conditions under which
employees could be discharged.' 3
On the basis of Schwab's life-cycle
analysis, Issacharoff argues for a European-style severance scheme in
which, after two years of employment, a discharged employee is presumptively entitled to one month's severance pay for every year of service,
unless the employer can establish that the discharge was for cause. 24
The Symposium participants discussed additional arguments that other
authors have raised concerning the failure of individual bargaining in the
negotiation of efficient employment security provisions.'
some scholars argue that employees systematically underestimate the
employers an incentive to act opportunistically by firing employees before they receive their late tenure
payoff. Id. at 19. It is also possible for an employer to act opportunistically with respect to employees
early in their job tenure by, for example, firing a salesperson after she makes a sale but before she receives her commission.
20. See Schwab, supra note 1, at 32-51 (arguing that the pattern of court protection of employees
mimics the life-cycle theory, protecting workers at the beginning and the end of their careers when they
are most vulnerable to employers). For an example of the application of the implied covenant of good
faith and fair dealing in the employment context, see Fortune v. National Cash Register Co., 364
N.E.2d 1251 (Mass. 1977) (finding that an employer who fired an employee in order to avoid having
to pay him a large commission violated the implied covenant of good faith and fair dealing).
21. See Verkerke, supra note 1, at 863, 848-63 ("[Schwab's] life-cycle just cause hypothesis is
far less consistent with the pattern of employment contract decisions than an alternative hypothesis of
systematic jurisdictional variation.").
22. In terms far too romantic for the dismal science of economics, Issacharoff likens the bargaining
relationship between an employer and an employee to courtship "between a polygamist and a
monogamist." Issacharoff, supra note 4, at 1795. To formalize his analogy for my fellow economic
nerds, I understand Issacharoff to be making two arguments. First, employers will be unable to identify perfectly the productivity of potential employees, and employees will be hesitant to request employment security in individual bargaining because this may falsely signal that they will be bad workers.
See David I. Levine, Just-CauseEmployment Policies in the Presence of Worker Adverse Selection, 9
J. LAB. EcoN. 294, 295 (1991). Second, employers have more bargaining power than employees in
individual bargaining because they deal with many employees, few of whom are individually of vital
importance to the enterprise, while the employee deals with only one employer who provides the
employee's means of sustenance. It should be noted that information asymmetry may also prevent
employers from initially offering employment security provisions for fear of attracting only bad
employees. Verkerke, supra note 1, at 902-03.
23. Issacharoff, supra note 4, at 1794-96.
24. Id. at 1806-07.
25. For a good summary of these arguments and an intelligent rebuttal, see Verkerke, supra note
1, at 898-912; see also Dau-Schmidt, supranote 11, at 688-92 (assessing the advantages and disadvantages of individual bargaining as a method of obtaining employment security).
benefits of employment security provisions because they underestimate the
probability and costs of discharge.26 Similarly, employers may systematically overestimate the costs of unjust discharge suits based on contractual
protections." If employees systematically underestimate the benefits of
employment security while employers systematically overestimate its cost,
the parties will negotiate too little employment security through individual
bargaining. Finally, it has been argued that, because working under a
contract with just-cause discharge provisions requires a costly managerial
system for documenting employee performance, employment security is a
public good in the workplace and employees will bargain for too little of
that good in individual negotiations.'
These arguments, along with
Issacharoff's arguments above concerning asymmetries in information and
bargaining power, suppose a more pervasive failure in individual
bargaining than the third-party-cost and life-cycle arguments proposed by
Schwab and Estlund, and thus could be used to justify a more extensive
intervention on the province of individual bargaining by the courts or the
In my mind there is no doubt that individual bargaining does, at least
in some ways, fail to efficiently accommodate employers' and employees'
conflicting preferences with respect to employment security. Schwab and
26. Under established theories on the resolution of cognitive dissonance, "people prefer not to
think about unpleasant possibilities." Verkerke, supra note 1, at 898. Also, according to prospect
theory, people tend to underestimate the expected losses from relatively remote, low-probability events.
See Paul Slovic et al., Facts Versus Fears: Understanding Perceived Risk, in JUDGMENT UNDER
UNCERTAINTY: HEURISTICS AND BIASES 464, 465 (Daniel Kahmeman et al. eds., 1982) (arguing that
people underestimate the risk of rare events unless they are publicized); Daniel Kalmeman & Amos
Tversky, Subjective Probability:AJudgmentofRepresentativeness, 3 COGNITIVEPSYCHOL. 430 (1972)
(exploring the factors that influence people's subjective assessments of risk). If workers tend not to
think about the unfortunate circumstance of discharge and also tend to underestimate the probability of
that event, then it stands to reason that they would tend to underestimate the probable costs of
27. Lauren B. Edelman et al., Professional Construction of the Law: The Inflated Threat of
Wrongful Discharge,26 LAW & SOC'Y REV. 47, 64 (1992).
28. Douglas L. Leslie, LaborBargaining Units, 70 VA. L. REV. 353, 355-56 (1984). Verkerke's
data seem to support the hypothesis that the standard of discharge is a public good because most
employers have all their employees on the same standard of discharge. See Verkerke, supra note 1,
at 866. A "public good" is a good or benefit that exhibits the characteristic that if one person obtains
it, others cannot be excluded from its enjoyment. For example, if it is efficient for employers to
operate under only one standard of discharge for their employees, then if one employee negotiates a
just-cause standard of discharge, all employees will enjoy the benefits of that standard. Employees will
individually bargain for too little of public goods because in their individual negotiations they will tend
not to ask for such goods with the hope that another employee will negotiate such a term from which
they can all benefit. See ROBERT H. FRANK, MICROECONOMICS AND BEHAVIOR 646-52 (1991)
(discussing the concept of public goods and contending that private provisions of public goods may be
lower than the socially optimal level).
29. If defects in individual bargaining produce employment security contract terms that differ significantly from what the efficient terms would be, then one could argue that the judicial or legislative
imposition of the efficient employment security terms would increase wealth.
Texas Law Review
Estlund have made compelling and largely noncontroversial arguments
concerning the externalization of costs in employers' decisions to fire
employees for refusing to break the law, fulfilling a public obligation
(including "whistleblowing"), or exercising a statutory right. 30 Schwab's
arguments concerning employers' opportunistic behavior associated with
the life-cycle also seem well founded, although Verkerke has convinced me
that Schwab's normative arguments for common-law ...
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