Referral Hiring and Wage Formation in a Market with Adverse Selection

40 Pages Posted: 6 May 2019 Last revised: 22 Feb 2021

See all articles by Aurelie Dariel

Aurelie Dariel

New York University (NYU) - New York University Abu Dhabi

Arno Riedl

Maastricht University; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Netspar

Simon Siegenthaler

University of Texas at Dallas, Naveen Jindal School of Management

Date Written: February 22, 2021

Abstract

The widespread use of employee referrals raises questions regarding how they affect labor market outcomes: Does referral hiring lead to a more efficient allocation of workers compared to when hiring is possible only on a competitive market? To utilize the social links of their current employees, are employers willing to pay a wage premium? We present a game-theoretic model and provide results from a laboratory experiment to address these questions. In line with the theoretical predictions, employers often hire via employee referrals, which in turn mitigates adverse selection and elevates wages. Importantly, employers anticipate the future value of incumbent high-productivity employees' social links and are willing to take the risk of offering higher wages, even when hiring on the competitive market. We also find that employers' risk aversion and the dynamic nature of the hiring process can help account for the inefficiency remaining in the labor market.

Keywords: Adverse selection, referral hiring, wage formation, social links

JEL Classification: C92, D82, D85, E20

Suggested Citation

Dariel, Aurelie and Riedl, Arno M. and Siegenthaler, Simon, Referral Hiring and Wage Formation in a Market with Adverse Selection (February 22, 2021). Available at SSRN: https://ssrn.com/abstract=3368383 or http://dx.doi.org/10.2139/ssrn.3368383

Aurelie Dariel

New York University (NYU) - New York University Abu Dhabi ( email )

PO Box 129188
Abu Dhabi
United Arab Emirates

Arno M. Riedl (Contact Author)

Maastricht University ( email )

Department of Microeconomics & Public Economics
P.O. Box 616
Maastricht, 6200 MD
Netherlands

HOME PAGE: http://www.arnoriedl.com

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Netspar ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Simon Siegenthaler

University of Texas at Dallas, Naveen Jindal School of Management ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States

HOME PAGE: http://www.simonsiegenthaler.com

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