Employment, Hours and the Welfare Effects of Intra-Firm Bargaining

Intra-firm bargaining between a multiple-worker firm and an individual employee leads to overhiring. Taking advantage of the decreasing returns to scale in employment, the firm can reduce the marginal product by hiring an additional worker, thereby reducing the bargaining wage paid to all existing employees. We show that this externality is amplified when firms can adjust hours per worker as well as employment. Hours are too low at the steady state. This misallocation of labor leads to sizeable welfare losses. Our finding is important for economies in which hours adjustment play an important role as it does in many Euro Area countries.