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Wage Setting Under Targeted Search

When setting initial compensation, some firms set a fixed, non-negotiable wage while others bargain. In this paper we propose a parsimonious search and matching model with two sided heterogeneity, where the choice of wage-setting protocol, wages, search intensity, and degree of randomness in matching are endogenous. We find that posting and bargaining coexist as wage-setting protocols if there is sufficient heterogeneity in match quality, search costs, or market tightness and that labor market tightness and relative costs of search play a key role in the choice of the wage-setting mechanism. We validate the model and find that bargaining prevalence is positively correlated with wages, residual wage dispersion, and labor market tightness, both in the model and in the data. We find coexistence of wage setting protocols arises from miscoordiation among firms and may lead to large welfare losses. It is precisely in these cases that a policy of mandatory wage posting tends to further reduce welfare.

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