Referrals

Abstract:     
Specialization requires that workers deal with some valuable opportunities themselves and refer other, possibly unverifiable, opportunities to other workers. How do markets and organizations ensure the matching of opportunities with talent in the presence of informational asymmetries about their value? The cost of providing incentives for effort in this context is that they increase the risk of the agent appropriating an opportunity she should refer upstream. Thus spot markets are severely limited in their ability to support referrals, as they involve very powerful effort incentives on those opportunities kept by the referring agents. We show that partnerships, in which agents agree to share opportunities and the income from the opportunities, appear endogenously as a solution to this problem. Partnership contracts support better communication rules at the expense of biasing effort provision away from first best for all activities. The structure of the contract depends both on the frequency of communications and on the interaction between the relative skill of the agents and the direction of the referral flow.

Number of Pages in PDF File: 51

working papers series