Why Do Firms Hire Using Referrals? Evidence from Bangladeshi Garment Factories

Abstract

I argue that firms use referrals from current workers to mitigate a moral hazard problem. I develop a model in which referrals relax a limited liability constraint by allowing the firm to punish the referral provider if the recipient has low output. I test the model's predictions using household survey data that I collected in Bangladesh. I can control for correlated wage shocks within a network and correlated unobserved type between the recipient and provider. I reject the testable implications of models in which referrals help firms select unobservably good workers or are solely a non-wage benefit to providers.

Employee Referral, Social Proximity, and Worker Discipline: Theory and Suggestive Evidence from India

“…While the main rival explanations may contribute to the high job entry through workplace insiders, they are hard to reconcile with the observations and analyses presented here. Our results support Kugler's (2003) and Heath's (2018) work which see moral hazard as an important driver of workplace referrals, but add fine-grained empirical observations and new theoretical insights about how social ties and referee incentives shape referral prevalence and outcomes. Note: OLS with robust SEs (in parentheses).…”

“…For the more specific predictions of our model, which are consistent with but offer more nuance than Antoninis (2006) and Heath (2018), 28 we find a wage penalty for workers recruited through referral but only into bottom tier jobs: these informal, low status jobs involve hard manul labor and likely acute retention and discipline problems. Montgomery (1991), Kugler (2003) and Simon and Warner (1992) all predict a referral wage premium, which is inconsistent with our observations: there would be no referral wage penalty after controlling for worker ability if the 'favoritism as costly for the firm' explanation was correct.…”

“…In Heath (2018), as in our model, referees understand that they can be punished if their recommended worker misbehaves. However, in her model there is no role for referee incentives or for the strength of ties.…”

“…However, in her model there is no role for referee incentives or for the strength of ties. Neither Kugler (2003) nor Heath (2018) consider referee incentives explicitly, which we analyze next.…”

“…The mechanism we explore has been touched upon by Kajisa (2007), and is studied by Kugler (2003), Iversen, Sen, Verschoor and Dubey (2009) and Heath (2018). Kugler (2003) and Heath (2018) both assume that referee incentives are satisfied. Our paper adds new theoretical insights by endogenising the referee's incentives and the strength of the tie between the employee referee and the new recruit.…”