Employee referrals and the inter-industry wage structure

This paper investigates the role of employee referrals in the labor market. Using an original data set, I find that industries that pay wage premia and have characteristics associated with high-wage sectors rely mainly on employee referrals to fill jobs. Moreover, unemployment rates are higher in industries which use employee referrals more extensively. This paper develops an equilibrium matching model which can explain these empirical regularities. In this model, the matching process sorts heterogeneous firms and workers into two distinct groups: referrals match "good" jobs to "good" workers, while formal methods (e.g., newspaper ads and employment agencies) match less-attractive jobs to disadvantaged workers. Thus, well-connected workers who learn quickly about job opportunities use referrals to jump job queues, while those who are less well placed in the labor market search for jobs through formal methods. The split of firms and workers between referrals and formal search is, however, not necessarily efficient. Congestion externalities in referral search imply that unemployment would be closer to the optimal rate if firms and workers 'at the margin' searched formally.