Why Do Firms Hire Using Referrals? Evidence from Bangladeshi Garment Factories

Abstract

I argue that firms use referrals from current workers to mitigate a moral hazard problem. I develop a model in which referrals relax a limited liability constraint by allowing the firm to punish the referral provider if the recipient has low output. I test the model’s predictions using household survey data that I collected in Bangladesh. I can control for correlated wage shocks within a network and correlated unobserved type between the recipient and provider. I reject the testable implications of models in which referrals help firms select unobservably good workers or are solely a nonwage benefit to providers.