Information Cascades on the Labor Market

Abstract

A model of herding behavior on the labor market is discussed where employers only receive signals with limited precision about the workers' types, but can observe previous employers' decisions. In particular, we study a situation where the employer and the worker can influence the signal probabilities, in the sense that the employer tries to increase the precision of the signal about the worker's type whereas the worker tries to get a good signal, independent of her type. In a two-period model, we derive conditions for an equilibrium in which only down-cascades occur, i.e., the second employer does not hire a worker with a bad history even if he receives a favorable private signal about the worker's type, but he does follow his own signal if the worker's history is good.

Keywords: herding, endogenous signals, hiring decisions