Job security, asymmetric information, and wage rigidity

We consider a labour market with risk averse workers, directed search and asymmetric information in which firms can commit to wage contracts but not to retain workers. The model predicts that in downturns (i) there is equal treatment of incumbents and new hires, (ii) wages are insensitive to the severity of the downturn, (iii) this leads to an amplified employment effect, and (iv) wages are determined by forecasts of labour market conditions rather than actual values. By contrast in upswings, new-hire wages are more attuned to actual conditions than forecasts, whilst incumbent wages remain relatively rigid. We find that these novel predictions are well supported in German administrative data.

Automated summary

This study examines a labor market with risk averse workers, directed search, and asymmetric information. The findings suggest that in economic downturns, incumbents and new hires are treated equally, wages are not sensitive to the severity of the downturn, resulting in an amplified employment effect, and wages are determined by forecasts of labor market conditions. In contrast, during economic upswings, new-hire wages are more responsive to actual conditions, while incumbent wages remain relatively rigid.