STRATEGIC WITHHOLDING OF FIRM‐SPECIFIC SKILLS IN WAGE BARGAINING
| Date | 01 May 2010 |
| Author | Ayşe Mumcu |
| Published date | 01 May 2010 |
| DOI | http://doi.org/10.1111/j.1467-9485.2010.00513.x |
STRATEGIC WITHHOLDING OF
FIRM-SPECIFIC SKILLS IN WAGE
BARGAINING
Ay
S
e Mumcu
n
ABSTRACT
The bargaining relationship between a firm and its incumbent worker who possesses
firm-specific human capital is examined. It is shown that the worker’s ability to
withhold his/her skills strategically increases his/her bargaining power. Multiple
efficient as well as inefficient equilibria involving delays in negotiation are
characterized. When the firm has outside options, the range of both efficient and
inefficient equilibria shrinks; moreover, delays are shortened in inefficient
equilibria. The model predicts that wages are procyclical.
I Intro ductio n
Employment contracts are inherently incomplete. In the absence of compre-
hensive contracts, productive efficiency requires that successive adaptations to
changing job and market conditions take place. In the implementation of these
adaptations, parties may find it profitable to bargain ex post over the terms of
the contract during both the contract period, and the contract renewal stage. If
the labor market is competitive, the ex post bargaining between firm and
employee results in an efficient allocation, as the firm can replace employees at
no cost, without any disruption in production. However, most jobs involve non-
trivial, firm-specific skills and information that develop over the course of the
worker’s employment.
1
As Williamson et al. (1975) indicate, although a firm’s
initial hiring decision takes place in a competitive labor market, once the
worker’s skills are developed as a result of experience, the employment
relationship resembles a bilateral monopoly. Therefore, in the ex post bargaining
game the hold-up problem may arise. This, in turn, may create both ex ante and
ex post inefficiencies.
The role of firm-specific skills has been a major issue in labor economics, and
a large number of empirical studies investigated the effects of such skills on
n
Department of Economics, Bog
˘azic¸ i University, Bebek, 34342, Istanbul, Turkey. E-mail:
mumcu@boun.edu.tr.
1
Employees such as high-level managers, sales representatives, key product engineers, and
members of production teams possess firm-specific human capital, and firms cannot replace
them with new, inexperienced workers at the spot labor market.
Scottish Journal of Political Economy, Vol. 57, No. 2, May 2010
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workers’ mobility, efficiency of labor legislation, and reaction to business cycles
and/or adoption of new technologies. This paper studies the effect of firm-
specific skills in terms of wage-setting and distribution of surplus, with a
particular emphasis on the bargaining relationship between a firm and its
incumbent worker who possesses firm-specific human capital. The specialized
skills and information, called firm-specific human capital,
2
develop either as a
part of on-the-job training, or accrue naturally during the course of employ-
ment.
3
When firm-specific skills are the result of on-the-job training, which is an
investment in human capital, both ex ante and ex post inefficiencies are created
by the possibility of ex post bargaining. Ex ante inefficiencies arise because the
parties’ incentives to invest in specific human capital are distorted,
4
whereas ex
post inefficiencies occur because workers may strategically withhold their
specialized skills during the ex post bargaining process and cause delays in
bargaining. Numerous studies have analyzed ex ante inefficiencies created by the
hold-up problem.
5
However, the question of how the strategic withholding of
these skills may create ex post inefficiencies in worker-firm bargaining has been
insufficiently explored.
In this paper, using a non-cooperative bargaining model, it is shown that, in
the contract renewal stage, the workers’ ability to strategically withhold their
skills may increase their bargaining power vis-a
`-vis the firm. While the firm can
threaten to fire the worker and hire a new skilled worker, this threat may not be
immediately put into effect due to market frictions. However, the incumbent
worker’s bargaining power is reduced to the extent that this threat is credible. It
is this very ability of the worker to withhold his/her skill that creates multiple
equilibria involving immediate agreement as well as inefficient equilibria in
which delays occur in real time. This supports the argument by Williamson et al.
(1975) that sequential spot contracting in the labor market is not efficient when
firm-specific human capital is important. Instead, hierarchical organization of
labor such as internal labor markets promotes efficiency by avoiding individual
bargaining.
6
2
Familiarity with the physical environment (Doeringer and Piore, 1971), customer
relationships (Anderson and Schmittlein, 1984), and the ability to communicate and work
effectively with team members (Klein, 1988; Mailath and Postlewaite, 1990) are all examples of
firm-specific human capital.
3
According to Green and Montgomery (1998), more than one in six young people acquired
only firm-specific skills in their first substantial job.
4
Becker (1962) was the first to consider incentives to invest in specific human capital.
5
The literature on the hold-up problem in bilateral relationships and its remedies is extensive.
For instance, Grossman and Hart (1986) studied incentives regarding relationship-specific
investment when there is contractual incompleteness, while Rogerson (1992), Chung (1991), and
MacLeod and Malcomson (1993) are among those who examined contractual solutions to ex-
ante inefficiency created by the ex-post hold-up problem.
6
The internal labor markets paradigm, which is pioneered by Doeringer and Piore (1971),
argues that there are hierarchical career structures within a firm. The wages are attached to jobs
rather than workers, which eliminates inefficient bargaining between the firm and its incumbent
workers. In fact, recent empirical analysis of personnel data of large firms (see Baker et al.,
1994; Dohmen, 2004; Gibbs and Hendricks, 2004) reveal that formal salary systems mainly
determine the wage policy of a firm, where the employees’ seniority wage profiles are largely
AYREMUMCU188
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