Internal rent seeking, works councils, and optimal establishment size

► We analyze the optimal establishment size against the background of rent-seeking workers and the influence of works councils. ► Establishment size has a discouragement effect on the level of individual rent seeking but also a quantity effect. ► The interplay of both effects determines whether the employer chooses an inefficiently small or large establishment size. ► Introduction of a works council restores efficient establishment size although it is purely used as rent-seeking device. ► Empirically we find a dominance of the discouragement effect over the quantity effect in establishments without works council.