Job security, asymmetric information, and wage rigidity

Abstract

We consider a labour market with risk averse workers, directed search and asymmetric information in which firms can commit to wage contracts but not to retain workers. The model predicts that in downturns (i) there is equal treatment of incumbents and new hires, (ii) wages are insensitive to the severity of the downturn, (iii) this leads to an amplified employment effect, and (iv) wages are determined by forecasts of labour market conditions rather than actual values. By contrast in upswings, new-hire wages are more attuned to actual conditions than forecasts, whilst incumbent wages remain relatively rigid. We find that these novel predictions are well supported in German administrative data.