Relational Contracts in Competitive Labor Markets∗

This paper characterizes the distribution of jobs in a relational contracting model where both employed and unemployed workers compete for jobs. In equilibrium, identical firms offer a continuous distribution of contracts, with some firms offering high-wage, high-productivity contracts and others offering low-wage, low-productivity contracts. An increase in on-the-job-search affects equilibrium contracts in two ways. First, by decreasing retention rates it leads to a deterioration in the quality of jobs. Second, by reducing the opportunity cost of employment it allows firms to enter at the bottom of the market. If employed workers receive better offers than the unemployed then free entry leads to full employment, and wage dispersion rather than unemployment incentivizes workers.