Many firms actively use employee referrals to hire new workers. Are these practices profitable, and if so, why? A model is developed where referrals may improve selection and reduce moral hazard, and is tested using novel and extremely detailed productivity and survey data from hundreds of thousands of workers in nine large firms in three industries: call-centers, trucking, and high-tech. Referred workers have similar characteristics, productivity, and productivity growth compared to non-referred workers, but are 8-20% less likely quit in all three industries, and are less likely to engage in misbehavior. Three new strategies to separate treatment from selection impact of referrals indicate that referrals benefit firms primarily by selecting workers with a better fit for the job, as opposed to selecting workers with higher overall quality, by affecting worker behavior, or by changing job amenities. Digging further into how this superior selection occurs, we document the tendency of workers to refer others like themselves, not only in characteristics but in behavior (e.g. productive workers refer other productive workers; unsafe workers refer other unsafe workers), and argue that firms may gain by incentivizing referrals most from their highest quality workers. Structurally estimating a dynamic extension of our model, we find that referred workers increase firm profits by 10-20% relative to non-referred workers.
(Coauthors Stephen Burks, Bo Cowgill, Michael Housman.)