Unravelling in Two-Sided Matching Markets and Similarity of Preferences

Hiring policy is one of the most important determinants of a firm's success. The hiring process calls for collecting information in order to choose the best individual from among the candidates. In certain markets, however, firms hire workers long before all the pertinent information is available. Those early matches often turn out to be inefficient when the job starts. This phenomenon of contracting long before the job begins, and before relevant information is available, is called unravelling. Unravelling has been recognized as a serious problem in numerous markets, and measures designed to preclude it (such as centralized clearinghouses and enforcement of uniform hiring) have not always been successful. In order to provide insights for designing better measures to prevent unravelling in markets prone to it, this paper examines a two-sided matching market populated by firms on one side and workers on the other. Key concepts include:

• Unravelling prevails in certain markets because some employers see a better chance to hire their most-preferred candidates when they contract early than when they wait.
• Unravelling becomes more likely as firms' preferences over workers grow more similar. This is the case because when firms' preferences are very similar, lower-ranked firms can be matched with their most-preferred workers only by contracting with them early.
• Despite insufficient information in the first period, it may be worthwhile for lower-ranked firms to bear the risk and contract early.
• The firms most likely to unravel are those "in the middle"—bad enough to prefer the uncertainty of early contracting, but good enough to be accepted.
• From a policy standpoint, a mechanism that precludes unravelling is preferable in some circumstances.