Asymmetric Information, Firm Size and Promotion Policy

This paper analyzes an economy in which firms cannot observe the ability of their employees upon hiring them. We augment the Waldman (1984a) framework by endogenousing firm size and show that in an environment with free entry, in the only Strong Nash Equilibrium, each firm employs workers with different amounts of ability. These discrepancies lead to variance in firm size and a positive correlation between firm size and wages. We also show that the each firm's assignment policy is efficient; however, firms that employ workers with greater ability are above optimal size.

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