Firm Wages in a Frictional Labor Market

Abstract

This paper studies wage setting in a directed search model of multiworker firms facing within-firm equity constraints on wages. The constraints reduce wages, as firms exploit their monopsony power over their existing workers, rendering wages less responsive to productivity in doing so. They also give rise to a time inconsistency in the dynamic firm problem, as firms face a less elastic labor supply in the short run than in the long run, making commitment to future wages valuable. Constrained firms find it profitable to fix wages, and doing so is good for worker welfare and resource allocation in equilibrium. (JEL E24, E32, J31, J42, J63, J64, M52)