Holdups and Efficiency with Search Frictions

A natural holdup problem arises in a market with search frictions: firms have to make a range of investments before finding their employees, and larger investments translate into higher wages. In particular, when wages are determined by ex post bargaining, the equilibrium is always inefficient: recognizing that capital-intensive production relations have to pay higher wages, firms reduce their investments. This can only be prevented by removing all the bargaining power from the workers, but this, in turn, depresses wages below their social product and creates excessive entry of firms. In contrast to this benchmark, we show that efficiency is achieved when firms post wages and workers can direct their search toward more attractive offers. This efficiency result generalizes to an environment with imperfect information where workers only observe a few of the equilibrium wage offers. We show that the underlying reason for efficiency is not wage posting per se, but the ability of workers to direct their search toward more capital-intensive jobs. Copyright 1999 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.