Strategic Referral and On-the-Job Search Equilibrium

Abstract

A majority of workers use referral when searching for a job, looking for a better match. To study how and to what extent referral affects match quality and aggregate labor market, I build an equilibrium on-the-job search model in which workers have two ways to search, formal application and referral, and information on information on match quality is endogenously transmitted through referral. The model characterizes the extent of information transmission in different jobs as an outcome of a strategic game, and the equilibrium of the game and workers' optimal search interact with each other in general equilibrium. The endogenous information explains why workers in a higher position in the job-ladder benefit more from a referral, which is consistent with empirical findings of this paper. I calibrate the model by matching the observed referral wage premium for different workers. The calibration shows a significant welfare gain 2.42% - 9.01% from referral. The welfare gain is more substantial when underlying match quality is dispersed, or when employers' screening ability is low. The quantitative result indicates that active labor market policy can have significant welfare effects, and the effects are larger in a labor market with high uncertainty.