Adverse Selection and Training Distortions for Monopsony Power

Abstract

Even in otherwise competitive labor markets, employers derive monopsony power from privately observing their employees’ performance. We show that firms (and workers) can strategically invest in training to expand (or curb) the ensuing adverse selection problem. By supplying firm-specific training that ensures the worst-matched workers are not too bad or general training that benefits the best employees, firms indirectly commit to retaining employees more often. This exacerbates the lemons’ problem faced by rival firms in the labor market, and, so, lowers equilibrium wages. Instead, workers want to invest in training that raises the productivity of the less able. These forces can lead to investments in training that are socially excessive, in contrast to most extant theories. The paper also highlights how demands for training targeted at particular regions of the human capital distribution arise.