Endogenous scope of firm-union bargaining with vertical pay comparisons

There is strong evidence that employees’ motivation and incentives in the workplace are affected by vertical pay comparisons. In a stylized Cournot duopoly model with firm–specific unions that institutionalize workers’ vertical fairness concerns, we show that universal wage employment (w,e)–bargaining may arise as the equilibrium scope of bargaining institution. We thus propose that intra–firm vertical fairness concerns may resolve the mismatch between recent findings in the empirical literature on labor market institutions and the predictions of traditional models that universal (w,e)–bargaining will never arise in equilibrium (the “Scope of Bargaining Puzzle”). We derive a number of testable hypotheses that address the recent shift towards more decentralized bargaining institutions, the decline in unions’ bargaining power, and the prevalence of (w,e)–bargaining.