Competitive Search Equilibrium with Asymmetric Information∗

This paper explores the behavior of a model economy with search frictions and bilateral asymmetric information. Firms commit to employment contracts in an effort to attract workers. When a worker and firm meet, the worker must decide whether to supply effort to the employment relationship, thereby affecting the distribution of a match-specific productivity shock. Only the worker observes her effort choice and only the firm observes the realization of the shock. We prove that under a standard regularity condition, employment contracts take a simple form: the firm pays a wage w to a worker who is hired and a severance payment b to a worker who is dismissed. The firm hires the worker if her productivity exceeds w − b, while the gap between the wage and the severance payment is high enough to ensure that the worker supplies effort to the employment relationship. Asymmetric information unambiguously reduces the vacancy-unemployment ratio and reduces the probability that a meeting results in a match. These results are consistent with earlier findings in the implicit contracts literature, although the precise mechanism is somewhat different. For example, there is no risk-sharing motive in this framework; and mobility restrictions are explicitly caused by a primitive search friction. ∗We are grateful to Fernando Alvarez, Nancy Stokey, Nori Tawara, Iván Werning, and seminar participants at the 2004 NBER Summer Institute and the 2004 Society for Economic Dynamics Meetings in Florence for helpful comments. Shimer’s work is supported financially by grants from the National Science Foundation and the Sloan Foundation.