Temporary agency work and labor misallocation

The triangular employment relationship between outsourced workers, intermediary employers, and user firms has received limited theoretical attention. This paper seeks to address this gap by focusing on temporary agency work. We develop a two-period labor search model in which firms can create jobs directly or through a temporary work agency (TWA). In both instances, match quality depends on unobservable attributes of workers and job vacancies. The agency acts as a matchmaker, providing flexibility by spreading termination risks across firms and certifying assignment quality through worker screening. However, worker poaching by user firms reduces the returns on the agency's investments in recruitment and screening. This hold-up problem leads to inefficient assignments, prolonged TWA employment spells, and insufficient job creation. As in the data, TWA employment is more relevant for less skilled workers. We also find that these workers are more likely to be trapped in inefficient assignments. The distortions affecting agency workers are more severe when wages in direct-hire jobs are set through Nash bargaining rather than directed search. Although the hold-up problem in our model can be solved with transfers from poaching clients to the agency, such transfers are illegal in most EU countries.The paper concludes by presenting simulations and using Spanish data to validate the theoretical framework.