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We present a model in which efficient long-term employment relationships are
sustained by wage adjustments prompted by productivity shocks and outside job
offers. These wage adjustments occur only sporadically, due to the presence of
renegotiation costs. The model is amenable to analytical solution, yielding new insights
for several labor market phenomena, including: (1) key features of empirical
distributions of changes in pay among job stayers; (2) a near-“memorylessness”
property in wage dynamics whereby hiring wages have only limited influence on later
wages and allocation decisions; and (3) a crucial role for recruitment and retention
bonuses in sustaining efficient employment relationships.
