Wage Adjustment in Efficient Long-Term Employment Relationships

We present a model in which efficient long-term employment relationships are sustained by wage adjustments prompted by productivity shocks and outside job offers. These wage adjustments occur only sporadically, due to the presence of renegotiation costs. The model is amenable to analytical solution, yielding new insights for several labor market phenomena, including (i) key features of empirical distributions of changes in pay among job stayers, (ii) a near-“memorylessness” property in wage dynamics whereby hiring wages have only limited influence on later wages and allocation decisions, and (iii) a crucial role for recruitment and retention bonuses in sustaining efficient employment relationships. (JEL E24, E31, E32, J31, J64, M51, M52)