Efficiency Wages under Adverse Selection and the Role of Rigid Wages

Roman Inderst

No 99-56, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim, Sonderforschungsbereich 504, University of Mannheim

Abstract: We consider a competitive search equilibrium where firms' publicly observable wage offers lead to the formation of independent submarkets. While in the benchmark case workers' productivities can be verified at a distance, our main analysis concerns the case of adverse selection where workers can freely enter any submarket. Under adverse selection wages for more productive workers may increase as this serves as a commitment to dismiss detected lower types, which assures incentive compatibility. The wage increase is accompanied with higher (frictional) unemployment. In a second step we question the firms' ability to commit not to renegotiate wages downwards to avoid dismissal in case they detect a less productive worker. As separation becomes more costly under renegotiation, firms employing more productive workers will choose rigid wages even if this comes at additional costs. We argue that collective bargaining with a recognized union may provide such a commitment.

Pages: 24 pages
Date: 1999-04-13
Note: Financial Support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged. I benefitted from suggestions by Paul Heidhues, Holger Müller, Benny Moldovanu, and seminar participants at Mannheim University, Free University of Berlin, and Humboldt University of Berlin.
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