Julis Romo Rabinowitz Bldg
Princeton, NJ 08544
Institutional Affiliation: IIES, Stockholm University
NBER Working Papers and Publications
|February 2020||Network-Based Hiring: Local Benefits; Global Costs|
with , : w26806
Entrepreneurs, particularly in the developing world, often hire from their networks: friends, family, and resulting referrals. Network hiring has two benefits, documented extensively in the empirical literature: entrepreneurs know more about the ability of their network (and indeed they are often positively selected), and network members may be less likely to engage in moral hazard. We study theoretically how network hiring affects the size and composition (i.e., whether to hire friends or strangers) of the firm. Our primary result is that network hiring, while locally beneficial, can be globally inefficient. Because of the existence of a network, entrepreneurs set inefficiently low wages, firms are weakly too small, rely too much on networks for hiring, and resulting welfare losses increa...