Referral Hiring and Wage Formation in a Market with Adverse Selection
36 Pages Posted: 6 May 2019 Last revised: 2 Feb 2020
Date Written: January 31, 2020
Firms often rely on employee referrals to facilitate the hiring process and circumvent problems of asymmetric information. Important questions regarding how the use of employee referrals affects labor market outcomes arise: Does referral hiring via social links lead to a more efficient allocation of workers to firms, compared to when hiring is possible only on a competitive public market? In order to utilize the social links of their current employees, are firms willing to pay a premium above the competitive wage? We present a model that allows us to derive testable hypotheses and design a laboratory experiment to address these questions. In line with the predictions, we find that, if feasible, firms do hire via employee referrals, which in turn mitigates adverse selection and elevates wages. Importantly, firms anticipate the future value of incumbent high-productivity workers' social links, leading to higher wage offers even when hiring them solely in the competitive market. We also document that market efficiency falls short of the theoretical prediction and identify risk aversion and the dynamic nature of the hiring process as reasons for this inefficiency.
Keywords: Adverse selection, referral hiring, wage formation, social links
JEL Classification: C92, D82, D85, E20
Suggested Citation: Suggested Citation