Working for References

Abstract

We analyze the incentive and welfare consequences of job references in a large economy marked by moral hazard, limited liability, exogenous job separation, and structural unemployment. In the firm-optimal equilibrium, employers provide references whenever production is successful, and workers holding references are hired with certainty in the ensuing period. Compared to a setting without references: the bonus-contract offers are lower, yet the workers’ equilibrium effort is higher. Profits and welfare are higher, yet aggregate worker welfare is lower. Also, firms do not fully internalize the incentive effect of references and could typically increase profits and welfare by jointly raising bonuses. (JEL D82, D86, E24, J33, J41, L25, M51)