Holdup and hiring discrimination with search friction

A holdup problem on workers’ skill investment arises when employers can adopt discriminatory hiring norm to extract higher than socially optimal profit. In such an economy, productivity (skills) and non-productivity oriented characteristics (discrimination) both matter when determining which worker has priority. The resulting firms’ preference is an intertwined ranking order, by virtue of which the strategic interdependence in skill choices between discriminated and favored groups endogenously arises. We consider frictional markets with either posted or bargained wage. With posted wage, discrimination makes all workers worse off, firms gain. Through that payoff interdependence, we identify two effects along which one group’s underinvestment may benefit all groups. With bargained wage, the discriminated (favored) group is always worse (better) off, and firms incur cost for an intermediated range of bargaining power when they discriminate. This suggests that the holdup-discrimination problem can be mitigated when search is random and wages bargained, a result in the opposite direction of Acemoglu and Shimer (1999b). JEL Classifications: J7, J42