Group for Research in Decision Analysis

Explaining U-shape of the referral hiring pattern in a search model with heterogeneous workers

Anna Zaharieva Center for Mathematical Economics, Bielefeld University, Germany

This paper presents a search model with heterogeneous workers, social networks and endogenous search intensity. There are three job search channels available to the unemployed: costly formal applications and two costless informal channels - through family and professional networks. Low productivity workers expect low wages implying low incentives for preparing formal job applications. Hence low productivity workers rely on family referrals as a method of last resort. In contrast, professional referrals are used by firms to hire high productivity employees. Formal hiring is then a most frequent employment channel for workers in the middle range of the productivity distribution. This explains a U-shape referral hiring pattern observed in empirical studies and a strong selection of workers on productivity across the three channels. Moreover, combining family and professional referrals into one informal channel may generate a spurious result of wage premiums (penalties) if high (low) productivity workers are dominating in the empirical data and their productivity is not fully observable to the econometrician.

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