Wage Setting Protocols and Labor Market Conditions: Theory and Evidence

We theoretically and empirically examine how firms’ choices of wage-setting protocols respond to labor market conditions. We develop a simple model in which workers may be able to send multiple job applications and firms choose between posting wages and Nash bargaining. Posting a wage allows the firm to commit to lower wages than would be negotiated ex post, but eliminates the ability to respond to a competing offer, should the worker have one. We show that higher productivity lowers both the application-vacancy ratio and the fraction of firms posting a wage. On the other hand, an increase in the number of applications per worker raises the application-vacancy ratio while lowering the fraction of firms posting a wage. As a result, the equilibrium fraction of firms posting a wage may be positively or negatively correlated with the application-vacancy ratio, depending on the source of shocks. The model also implies that an increase in the number of applications per worker may lead to a decrease in the number of posting firms rather than a change in the wages posted by those firms. Empirically, we demonstrate that the model’s predictions are confirmed in a novel dataset from an online job board.

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