Wage Rigidity in a Competitive Incomplete Contract Market

Do employers and workers underbid prevailing wages if there is unemployment? Do employers take advantage of workers’ underbidding by lowering wages? We hypothesize that under conditions of incomplete labor contracts wage levels may positively affect workers’ propensity to cooperate. This, in turn, may prevent firms from underbidding or accepting the underbidding of workers. To get controlled evidence we conducted several experimental double auction markets. Double auctions are well known for their striking competitive properties. Our data show, however, the following regularities: (i) Workers’ underbidding is very frequent but employers refuse to accept workers’ low wage offers in markets with incomplete labor contracts. However, in the presence of complete labor contracts employers accept and actively enforce wages close to the competitive level. (ii) Workers’ effort is positively related to the wage level. Therefore, wage cutting is costly for the employer if workers have discretion over their effort level. This holds true even in the presence of explicit performance incentives. In markets with incomplete contracts firms’ high wage strategy increases the gains from trade and renders both workers and firms better off.