Big Firms Don’t Always Exercise Their Labor Market Power to Suppress Wages

People expect companies that possess the power to set wages will go as low as possible. But that’s not always the case. A new theoretical model proposes that when big companies allow their own departments to compete against each other for new employees, they can recruit more highly skilled workers at just slightly higher wages.

The work, “The strategic decentralization of recruiting,” was published in the Journal of Economic Theory, on March 20, 2023.

“There is a lot of discussion of big firms’ effects on markets, whether it’s the power to set prices or wages,” said Thomas Jungbauer, coauthor of the paper and assistant professor of strategy and business economics at the Cornell SC Johnson College of Business’s Samuel Curtis Johnson Graduate School of Management. “We asked ourselves, how bad are these large firms for workers in the labor market?”

To answer this question, Jungbauer and his coauthors built a theoretical model where large firms compete against small firms for employees with different skills. The model applies to labor markets for entry-level workers, where many offers are made at once to large numbers of workers.

The conclusion?

“Our answer is nuanced,” Jungbauer said.

Consider a large healthcare organization that owns most of the hospitals and doctors’ practices in one region. It likely has enormous power in the labor market. Specifically, local nurses won’t have many options to work elsewhere, and the organization could exploit that lack of choice by suppressing nurses’ wages.

This approach only works if the organization centralizes its hiring, Jungbauer explained, and existing data shows that many large firms do not. Instead, each department or unit within a large organization often handles its own hiring, competing for the same talent.

Why would an organization compete with itself? There is a strategic reason to decentralize hiring, according to the economic model developed by Jungbauer and his coauthors, Yi Chen, assistant professor of strategy and business economics at the SC Johnson College, and Zhe Wang, assistant professor of finance at Pennsylvania State University. By letting departments within the same organization compete with each other, the organization can recruit more highly skilled workers while only slightly raising wages. In this scenario, smaller firms employ the remaining lower skilled workers.

In general, many firms favor hiring stronger talent over suppressing wages, according to Jungbauer. “Not every firm that can sway the labor market is a threat to workers’ wages.”

Very large firms still can and do exercise their labor market power, however. When a company hires the majority of the available workers, it is already hiring a significant portion of highly skilled workers. Allowing the company’s departments to compete with each other wouldn’t make much of a difference in terms of talent recruitment, so the company is more motivated to drive wages down.

“Theoretical models offer a way to hypothesize about how things work in the real world, and then it’s the role of the empirical and data scientists to test the model,” Jungbauer said. “It would be interesting if an empirical economist took this model and tested it against existing data.”