Bargaining with Existing Workers, Over-hiring of Firms, and Labor Market Fluctuations

This paper investigates the effects of intra-firm bargaining on the standard real business cycle (RBC) search and matching model by explicitly considering the outside option of a firm in the bargaining with a new worker. In this paper, the outside option of a firm in the bargaining with a new worker is bargaining with existing workers (i.e., intra-firm bargaining). According to Stole and Zwiebel (1996), under the assumption that the firm facing diminishing marginal productivity of labor and its workers cannot commit to future wages, intra-firm bargaining gives the firm an incentive to hire an excessive amount of workers in order to drive wages of workers down. (i.e., the firm “over-hires†workers.) We show the outside option of a firm is crucial for the bargaining with a new worker in the sense that how much the firm pays existing workers, when the match breaks down, determines how many workers it over-hires. In this paper, wages in the outside option of a firm depend on the stochastic bargaining weight of existing workers (i.e., a bargaining shock), which can be identified through labor share data from U.S. Bargaining shocks affect the degree of over-hiring behavior of a firm, and in turn, provide another source to explain the behavior of labor markets in business cycles. The inclusion of intra-firm bargaining and bargaining shocks improves the capacity of the standard RBC search and matching model, especially in labor markets. Our calibrated model generates more volatile total hours, employment, hours per worker while labor share overshoots in response to productivity shocks. In particular, the volatility of employment in the model is similar to the actual U.S. data. Furthermore, the model provides a theory about the overshooting property of labor share, which can be explained by the general equilibrium effects of time-varying bargaining weights of existing workers and over-hiring behavior of the firm.