A Theory of the Firm with Non‐binding Employment Contracts

This paper examines an employment relation in which individual workers enjoy some bargaining power vis‐a‐vis the firm although they are not unionized. The main elements of the situations studied here are that the employment contracts are non‐binding across periods of production and that the firm has opportunities to replace workers. The paper analyzes a dynamic model in which the processes of contracting and recontracting between the firm and its workers are intertwined with the dynamic evolution of the firm's workforce. The analysis of the model is somewhat complicated because the employment level is a nondegenerate state variable that evolves over time and is affected by past decisions. The main analytical results characterize certain important equilibria: the profit maximizing and stationary equilibria. The unique stationary equilibrium is markedly inefficient: it exhibits inefficient over‐employment and the steady state wages coincide with the workers' reservation wage. It confirms earlier results derived by Stole and Zwiebel (1996a, b) in the context of a static model and shows that they are very robust even when the firm has nearly frictionless hiring opportunities. In contrast, in the profit maximizing equilibrium the outcome is nearly efficient and the wage exhibits a mark‐up over the reservation wage.     

ON‐THE‐JOB SEARCH AND MORAL HAZARD

We analyze the interaction between intertemporal incentive contracts and search frictions associated with on‐the‐job search. In our model, agency problems call for wage contracts with deferred compensation. At the same time workers do on‐the‐job search. Deferred compensation improves workers' incentives to exert effort but distorts their on‐the‐job search decisions. We show that deferred compensation is less attractive when the value to the worker–firm pair of on‐the‐job search is high. Moreover, the interplay between search frictions and wage contracts creates feedback effects. If firms in equilibrium use contracts with deferred compensation, fewer firms with vacancies enter the on‐the‐job search market, and this in turn reduces the distortions created by deferred compensation. These feedback effects between the incentive contracts used and the activity level in the search markets can lead to multiple equilibria: a low‐turnover equilibrium where firms use deferred compensation, and a high‐turnover equilibrium where they do not. Furthermore, the model predicts that firms are more likely to use deferred compensation when search frictions are high and when the gains from on‐the‐job search are small.     

Higher Education Levels,Firms’ Outside Options and the Wage Structure

Abstract. We analyze the consequences of an increase in the supply of highly educated workers on relative and real wages in a search model where wages are set by Nash bargaining. A key insight is that an increase in the average education level exerts a negative externality on wages through its positive externality on the firms’ outside option. As a consequence, the real wage of all workers decreases in the short run. Since this decline is more pronounced for less educated workers, wage inequality increases. In the long‐run a better educated work force induces firms to invest more in physical capital. Wage inequality and real wages of highly educated workers increase while real wages of less educated workers may decrease. These results are consistent with the US experience in the 1970s and 1980s. Based upon differences in legal employment protection we also provide an explanation for the diverging evolution of real and relative wages in Continental Europe.     

Directed Search for Equilibrium Wage–Tenure Contracts

I construct a theoretical framework in which firms offer wage–tenure contracts to direct the search by risk‐averse workers. All workers can search, on or off the job. I characterize an equilibrium and prove its existence. The equilibrium generates a nondegenerate, continuous distribution of employed workers over the values of contracts, despite that all matches are identical and workers observe all offers. A striking property is that the equilibrium is block recursive; that is, individuals' optimal decisions and optimal contracts are independent of the distribution of workers. This property makes the equilibrium analysis tractable. Consistent with stylized facts, the equilibrium predicts that (i) wages increase with tenure, (ii) job‐to‐job transitions decrease with tenure and wages, and (iii) wage mobility is limited in the sense that the lower the worker's wage, the lower the future wage a worker will move to in the next job transition. Moreover, block recursivity implies that changes in the unemployment benefit and the minimum wage have no effect on an employed worker's job‐to‐job transitions and contracts.     

An Equilibrium Theory of Learning,Search, and Wages

We examine the labor market effects of incomplete information about the workers' own job‐finding process. Search outcomes convey valuable information, and learning from search generates endogenous heterogeneity in workers' beliefs about their job‐finding probability. We characterize this process and analyze its interactions with job creation and wage determination. Our theory sheds new light on how unemployment can affect workers' labor market outcomes and wage determination, providing a rational explanation for discouragement as the consequence of negative search outcomes. In particular, longer unemployment durations are likely to be followed by lower reemployment wages because a worker's beliefs about his job‐finding process deteriorate with unemployment duration. Moreover, our analysis provides a set of useful results on dynamic programming with optimal learning.     

SOCIAL COMPARISON AND EFFORT PROVISION: EVIDENCE FROM A FIELD EXPERIMENT

Social comparison has potentially far reaching consequences in many economic domains. We conducted a field experiment to examine how social comparison affects workers' effort provision if their own wage or that of a co‐worker is cut. Workers were assigned to groups of two, performed identical individual tasks, and received the same performance‐independent hourly wage. Cutting both group members' wages caused a decrease in performance. But when only one group member's wage was cut, the affected workers decreased their performance more than twice as much as when both workers' wages were cut. This finding indicates that social comparison among workers affects effort provision because the only difference between the two wage‐cut treatments is the other group member's wage level. In contrast, workers whose wage was not cut but who witnessed their group member's pay being cut displayed no change in performance relative to the baseline treatment in which both workers' wages remained unchanged. This indicates that social comparison exerts asymmetric effects on effort.     

The Determinants and Some Consequences of Unemployed Workers' Wage Demands

This paper studies the determinants and consequences in the early stages of the hiring process of unemployed workers' wage demands using direct data on workers' wage requests. We show that most unemployed workers want a wage close to their previous wage, and thus much more than they get in unemployment benefits. However, some groups, such as women, tend to demand lower wages. Moreover, we find that workers with high wage demands are contacted by firms less often than otherwise similar workers with lower wage demands. Thus, our results suggest that too high wage demands may contribute to high unemployment.     

Equilibrium Wage‐Tenure Contracts

In this study we consider a labor market matching model where firms post wage‐tenure contracts and workers, both employed and unemployed, search for new job opportunities. Given workers are risk averse, we establish there is a unique equilibrium in the environment considered. Although firms in the market make different offers in equilibrium, all post a wage‐tenure contract that implies a worker's wage increases smoothly with tenure at the firm. As firms make different offers, there is job turnover, as employed workers move jobs as the opportunity arises. This implies the increase in a worker's wage can be due to job‐to‐job movements as well as wage‐tenure effects. Further, there is a nondegenerate equilibrium distribution of initial wage offers that is differentiable on its support except for a mass point at the lowest initial wage. We also show that relevant characteristics of the equilibrium can be written as explicit functions of preferences and the other market parameters.     

Does Immigration Raise Blue and White Collar Wages of Natives? The Case of Italy

This paper analyses both theoretically and empirically the effects of immigration on the wage rate of native workers. There is rare evidence in empirical literature that immigration generates a fall in the wages of manual workers. By hypothesizing an economic system where advanced firms buy an intermediate good from traditional firms, which employ manual workers in both clean and dirty tasks, the latter being more disliked by native workers, we present a theoretical model that justifies these results. We conclude that native skilled wages always increase whereas native unskilled wages can both increase or decrease with immigration. An empirical analysis of the Italian labour market follows, showing that native workers' wages always rise with immigration.     

Wage Dispersion and Equilibrium Search Models: Some Evidence from Italy

This paper provides a structural estimation of an equilibrium search model with on‐the‐job search and heterogeneity in firms' productivities using a sample of Italian male workers. Results indicate that arrival rates of offers for workers are higher when unemployed than when employed and firms exploit their monopsony power when setting wages. As a result, workers earn far less than their marginal product. The model is then used to study regional labour market differentials in Italy. Wide variation in frictional transition parameters across areas helps to explain persistent unemployment and wage differentials.     

Minimum Wage Effects on Labor Market Outcomes under Search,Matching, and Endogenous Contact Rates

Building upon a continuous‐time model of search with Nash bargaining in a stationary environment, we analyze the effect of changes in minimum wages on labor market outcomes and welfare. Although minimum wage increases may or may not lead to increases in unemployment in our model, they can be welfare‐improving to labor market participants on both the supply and demand sides of the labor market. We discuss identification of the model using Current Population Survey data on accepted wages and unemployment durations, and show that by incorporating a limited amount of information from the demand side of the market it is possible to obtain credible and precise estimates of all primitive parameters. We show that the optimal minimum wage in 1996 depends critically on whether or not contact rates can be considered to be exogenous and we note that the limited variation in minimum wages makes testing this assumption problematic.     

Education,Mobility and Employers’ Monopsony Power: A Search‐theoretic Analysis

Abstract. We analyse the efficiency of schooling choices in a wage‐posting search equilibrium model with on‐the‐job search. The workers have multidimensional skills and the search market is segmented by technology. Education determines the scope — or adaptability— of individual skills. Individuals obtain schooling to leave unemployment more quickly and to climb the wage ladder rapidly through job‐to‐job mobility — that is, to speed up job shopping. Education reduces firms’ monopsony power in the wage determination by improving workers’ mobility. As a result, the wage distribution shifts rightward with aggregate schooling. However, the ratio of vacant jobs to job seekers also falls in each sector. Either one or the other externality may dominate, implying, respectively, under‐ or over‐education. A combination of minimum wage and schooling fee can decentralize the efficient allocation.     

Residential Location,Job Location,and Wages: Theory and Empirics

I develop a stylized partial on‐the‐job equilibrium search model that incorporates a spatial dimension. Workers reside on a circle and can move at a cost. Each point on the circle has a wage distribution. Implications about wages and job mobility are drawn from the model and tested on Danish matched employer–employee data. The model predictions hold true. I find that workers working farther away from their residence earn higher wages. When a worker is making a job‐to‐job transition where he/she changes workplace location he/she experiences a higher wage change than a worker making a job‐to‐job transition without changing workplace location. However, workers making a job‐to‐job transition that makes the workplace location closer to the residence experience a wage drop. Furthermore, low‐wage workers and workers with high transportation costs are more likely to make job‐to‐job transitions, but also residential moves.     

MEASURING LABOR MARKET FRICTIONS: A CROSS‐COUNTRY COMPARISON

In this paper we define and estimate measures of labor market frictions using data on job durations. We compare different estimation methods and different types of data. We propose and apply an unconditional inference method that can be applied to aggregate duration data. It does not require wage data, it is invariant to the way in which wages are determined, and it allows workers to care about other job characteristics. The empirical analysis focuses on France, but we perform separate analyses for the United States of America, the United Kingdom, Germany, and the Netherlands. We quantify the monopsony power due to search frictions and we examine the policy effects of the minimum wage, unemployment benefits, and search frictions. (JEL: J63, J64)     

SEARCH INTENSITY,DIRECTED SEARCH,AND THE WAGE DISTRIBUTION

We propose a search equilibrium model in which homogeneous firms post wages along with a vacancy to attract job seekers while homogeneous unemployed workers invest in costly job seeking. The key innovation relies on the organization of the search market and the search behavior of the job seekers. The search market is continuously segmented by wage level, individuals can spread their search investment over the different submarkets, and search intensity has marginal decreasing returns in each submarket. We demonstrate the existence of a nondegenerate equilibrium wage distribution. The density of this wage distribution is increasing at low wages and decreasing at high wages. The distribution can be right‐tailed, and, under additional restrictions, is hump‐shaped. Our results are illustrated by an example generating a Beta wage distribution.     

Labour Market Structures,Labour Market Policy and Wage Formation in the OECD

This paper investigates why the incentive to moderate wages in an environment of rising unemployment differs so strongly among the OECD countries. In the first part we develop an insider-outsider bargaining model in which the wage results from a confrontation of the insiders' wage claims and the employer's wage offer. The second part of the paper empirically tests the model's predictions for the determinants of wage flexibility. The degree of centralization of wage bargaining, the extent of active labour market policy and the characteristics of the unemployment benefit system are shown to be relevant determinants.     

The Impact on Inequality of Raising the Minimum Wage: Gap‐narrowing and Reranking Effects

Raising the minimum wage may reduce inequality by increasing the wages of low‐skill workers, but it may also increase inequality due to negative impacts on employment that produce wage losses. Using previous estimates of the elasticities of wages and employment to changes in the minimum wage in Colombia and Brazil, we show that the net impact on inequality of increasing the minimum wage may depend on the distributional weights used for inequality measurement. The results are obtained by decomposing the Gini index into reranking and gap‐narrowing effects. Inequality‐increasing reranking effects, which are associated with job losses, may dominate inequality‐decreasing gap‐narrowing effects, which are associated with wage gains, when high weights are placed on workers with low earnings. For standard distributional weights, however, the likely net impact is a reduction in wage inequality.     

Does Industrial Composition Matter for Wages? A Test of Search and Bargaining Theory

Does switching the composition of jobs between low‐paying and high‐paying industries have important effects on wages in other sectors? In this paper, we build on search and bargaining theory to clarify a key general equilibrium channel through which changes in industrial composition could have substantial effects on wages in all sectors. In this class of models, wage determination takes the form of a social interaction problem and we illustrate how the implied sectoral linkages can be empirically explored using U.S. Census data. We find that sector‐level wages interact as implied by the model and that the predicted general equilibrium effects are present and substantial. We interpret our results as highlighting the relevance of search and bargaining theory for understanding the determination of wages, and we argue that the results provide support for the view that industrial composition is important for understanding wage outcomes.     

DOES EMPLOYMENT PROTECTION CREATE ITS OWN POLITICAL SUPPORT?

This paper investigates the ability of employment protection to generate its own political support. A version of the Mortensen–Pissarides model is used for this purpose. If wages are set through Nash bargaining, workers value employment protection because it strengthens their hand in wage negotiations. Workers in high productivity matches benefit most from higher wages as they expect to stay employed for longer. By reducing turnover employment protection shifts the distribution of match‐specific productivity toward lower values. Thus stringent protection in the past actually reduces support for employment protection today. Introducing involuntary separations reverses this conclusion. Now workers value employment protection because it delays involuntary dismissals. Workers in low productivity matches gain most since they face the highest risk of dismissal. The downward shift in the productivity distribution is now a shift towards supporters.