By Hannah Jo Ellery
The success of a firm depends upon its workers, and thus upon how workers chose which firm to work for. One of the factors which may play a role in this decision is the reputation of the firm under consideration. Indeed, if reputation does play a role, it may have implications for the structures of labor markets and for markets more broadly, as firms which have had more time to build a reputation and rapport—incumbent firms—may have an entrenched advantage in hiring. In my thesis, I explore this possibility: do workers have a preference for firm reputation? What implications does a preference for reputation have for new firms in the labor market? Could prestige become a barrier to entry?
I first build a theoretical foundation for my hypothesis. In order to do so, I study a framework of worker-firm matching in a two-sided matching model, based in part on models of labor market matching introduced in Kelso and Crawford (1982). In this model, workers choose a single job and salary described by a contract, while firms choose multiple contracts, the union of which describes their total workforce.
Into this framework, I introduce reputation, taking as a base work done in Pycia and Yenmez (2017). Namely, I allow workers to care about the success of a company and what other workers think of that company. Notably, this is different from basic matching models, which avoid structures in which workers’ choices depend on the choices of others. When workers care about the success of a company, which depends upon the workers that are employed at that company, equilibrium matchings may not exist; instead, workers may wish to cycle between firms ad infinitum. Indeed, I show that in the context of a labor matching model with agents and utility functions, we cannot introduce a true preference for reputation. If workers’ choices depend on the current status of the labor market, as they would if the worker wants to be employed at a successful firm, equilibria may not exist. Thus, if workers care about the status of their firm, we may not be able to find a matching of workers to firms for the economy.
In spite of this, where equilibria do exist, I show that not only will markets tend to be more concentrated when workers have a preference for prestige, but it will also be weakly more difficult for a new start-up firm to enter a market where incumbents have already developed a reputation.
Second, I begin to show some evidence for such a preference for reputation in the labor market. In particular, I create a data set which collects the alma mater law schools of the employees of five large law firms, as well as the graduation year, hiring year, and former clerkships for each worker. Fortunately, large law firms are ranked explicitly on reputation and prestige in Vault’s annual Law 100 listing. This enabled me to compare the firm’s annual hire quality with their reputation, showing a strong and significant positive relation between reputation and hire quality both across and within firms.
Overall, this combination of theoretical and empirical evidence indicates that firm reputation may indeed play a role in the functioning of labor markets. Future research can help us to determine what industries feel the effects of this barrier the most, and how reputation impacts entry in practice.