Abstract
I study the efficiency of search equilibrium under decreasing returns to labor in production. Firms can sign long-term contracts with their workers which give them incentives to maximize the joint surplus associated with their relationship. When the firm hires a new worker, the terms of the contract are determined by bargaining over the marginal surplus. Long-term contracts solve the over-hiring problem identified by previous authors. However, the equilibrium is still not constrained efficient because large, low productivity firms search too intensively relative to small, high productivity firms. This potentially provides a novel justification for subsidizing vacancy creation by young, small firms.
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