Firms' Choices of Wage-Setting Protocols

We analyze a labor market characterized by search frictions in which firms choose between posting nonnegotiable wage offers and bargaining renegotiable wages with individual workers. We use the model to study the positive and normative implications of heterogeneous wage-setting strategies in labor markets, as well as the potential effect of policies that seek to regulate wage-setting. We analytically derive and test a prediction from the model regarding the cross-sectional prevalence of bargaining of wages among workers. We show how the equilibrium condition that determines the mix of bargaining and wage-posting firms in the labor market provides important identifying information for the surplus division parameter used by all bargaining firms. We estimate the model and use it to evaluate counterfactuals in which either wage-setting procedure is mandated. We find that eliminating bargaining reduces the overall gender gap in wages by 8 percent, the education gap by 4 percent, and residual wage dispersion by 10 percent, while leading to welfare losses for workers. On the other hand, mandating bargaining and renegotiation leads to larger reductions in these inequality metrics, and welfare gains for workers. Either policy raises output by 2 to 3 percent by eliminating inefficient job mobility. * We are grateful for receiving very helpful comments from participants of the 2021 SITE Labor Markets and Policy Reforms.