Subsidizing Consumption to Signal Quality of Workers

Abstract

A firm whose profits increase when outsiders believe that it pays high wages may induce its workers to over-consume goods that signal high compensation. One implication is that firms may lobby government to subsidize fringe benefits with high signaling value, such as company cars, to their employees. We show that under plausible conditions the provision of fringe benefits indeed can signal the firm's type. Moreover, we demonstrate the existence of multiple equilibria---one equilibrium has no firm providing certain fringe benefits, whereas another equilibrium has fringe benefits signal the firm's type. The paper further shows that a firm that provides the fringe benefit may oppose a government subsidizing it too heavily, because a large subsidy could destroy the signaling value of the benefit. The analysis shows that an employer may even provide a fringe benefit to employees who place no value on it. Our results are consistent with many stylized facts on the provision of fringe benefits by firms. More generally, we the model highlights how and why a firm may engage in behavior which signals the type of workers it hires.Signaling; Fringe benefits; Compensation