Lecture 24: Adverse Selection (Hiring)

What is the goal when hiring workers?

Hire the worker with the lowest cost per unit of productivity, not just the cheapest or the most skilled.

• firms choose the type of labor that minimizes cost per unit of productivity

What other costs must be considered when hiring?

Complementary capital (e.g., machinery costs) — this may make skilled labor more attractive if it uses capital more efficiently.

• when work requires capital as a compliment the firm is more likely to go with a skilled laborer if the capital is valuable

What’s the difference between one-sided and two-sided matching?

• One-sided: only one side has preferences (e.g., goods markets)

• Two-sided: both sides must agree (e.g., hiring, dating, school admissions)

What is the lemons problem?

When asymmetric information causes only low-quality participants (e.g., bad cars or bad workers) to enter the market, driving out high-quality ones.

What’s the difference between moral hazard and adverse selection?

• Moral hazard = unobservable actions (e.g., effort)- more what you do

• Adverse selection = unobservable types (e.g., skill level) - who you are

What is certification?

A way to signal worker quality based on schooling, credentials, reputation, etc.

• allows to solve asymmetry problem

solution to moral hazards

incentives

where do we see adverse selction most

worst types are usuallt teh first to participate

seen usually onlinw slellers health insurance and sized pay workers

What is signaling?

A costly action that reveals private information

-only high-quality types can afford to do it (e.g., earning a degree, long cover letter).

What is screening?

A firm-designed strategy to distinguish between types of applicants (e.g., pay structure, hiring process, referrals, ).

What is high-powered incentive screening?

Offering performance-based pay attracts high performers (but may drive away others

What is deferred compensation screening?

Low initial pay followed by higher pay over time — high-quality employees accept it for the long run; low-quality employees avoid it.

Why are referrals helpful/ referal screenings

Referrals help firms screen candidates with more info and usually result in higher productivity and lower turnover.

• allows to overcome asymmetry problem

What’s the benefit of delegating hiring to local managers?

Local managers may have better information about the candidate fit and raise sales/satisfaction (Wu et al. 2020)

What’s the risk of delegating hiring?

Managers may override objective tools (e.g., job tests) and make worse hires (Hoffman, Kahn, and Li 2018).