Delegated Recruitment and Hiring Distortions

Firms increasingly rely on recruiters to find talent. Recruiters are typically paid using refund contracts, which specify a payment upon a successful candidate suggestion and hire, and a refund if a candidate is hired but leaves for any reason during an initial period of employment. We study how recruiters and refund contracts shape talent selection. When a firm needs to fill a position, it engages a recruiter who observes private signals about a candidate’s productivity and decides whether to suggest this candidate to the firm. There is variation in both the candidates’ productivity and in the quality of information available about productivity. We characterize the unique equilibrium and show that refund contracts induce artificial risk aversion in both the recruiter’s suggestion strategy and the firm’s hiring strategy relative to a first-best benchmark. This risk aversion leads to candidates with lower expected productivity but more informative signals (“safe bets”) being favored over candidates with higher expected productivity but less informative signals (“diamonds in the rough”). Our findings imply that delegated recruitment generates statistical discrimination.