On the role of outside options in wage renegotiation

Abstract

We study a game‐theoretic model of wage renegotiation. A worker, after receiving a superior outside offer, initiates a wage renegotiation with his current employer. During the renegotiation, whenever a proposal is rejected, the worker decides whether to opt out. When the two parties are sufficiently patient, any wage level between the outside offer and the entire net surplus can be sustained in equilibrium. Opting out may also arise in equilibrium. This result is in stark contrast to existing studies, in which the outside option is sometimes a credible threat, but is never exercised in equilibrium.