Competitive Search Equilibrium with Asymmetric Information,” mimeo

This paper explores the behavior of a model economy with search frictions and bilateral asymmetric information. Firms commit to employment contracts in an effort to attract workers. When a worker and firm meet, the worker must decide whether to supply effort to the employment relationship, thereby affecting the distribution of a match-specific productivity shock. Only the worker observes her effort choice and only the firm observes the realization of the shock. We prove that under a standard regularity condition, employment contracts take a simple form: the firm pays a wage w to a worker who is hired and a severance payment b to a worker who is dismissed. The firm hires the worker if her productivity exceeds w − b, while the gap between the wage and the severance payment is high enough to ensure that the worker supplies effort to the employment relationship. Asymmetric information unambiguously reduces the vacancy-unemployment ratio and reduces the probability that a meeting results in a match. These results are consistent with earlier findings in the implicit contracts literature, although the precise mechanism is somewhat different. For example, there is no risk-sharing motive in this framework; and mobility restrictions are explicitly caused by a primitive search friction