Personnel Economics 7 1 Chapter 7: Turnover, Layoffs and Buyouts Is turnover always bad? Which...

1Personnel Economics 7

Chapter 7: Turnover, Layoffs and Buyouts

• Is turnover always bad?

• Which groups should be targeted for layoffs?

• Downsizing: is it possible to rely on “natürlichen Abgang” (voluntary quits)?


Benefits of long-term employment relationships

• Amortizing recruitment costs and training costs• Evaluation of abilities easier better job

assignment• Better performance evaluation incentive

contracts easier• Loyality to employer and co-workers,

identification with firm‘s goals• Promotion from within (internal labor market)


Costs of long-term employment relationships

• Inflexibility in a downturn• Inflexibility in work organization• Greater room for lobbying • Greater emphasis on formal rules for

promotion and seniority for pay scales• Internal labor market: not always the best

candidate available for position • See also Baron and Kreps, ch. 4 and 8


Mix of talents in the firm

• Turnover is not always bad– There is an optimal “mix” of experience

• Older workers have greater firm-specific human capital and general OJT.

• Younger workers have greater general human capital in form of formal schooling.

– Optimal ratio young to old is high when:• There is rapid technological change• OJT is less important than general skills• Firm/industry is not particularly idiosyncratic


If the firm goes through bad times...

• Wage cuts or job cuts?

• Two issues to consider: – Impact on remaining workers– Impact on laid off workers

– Treatment of laid off workers can influence behavior of remaining workers


Wage cut across the board

• Is it possible by law (Kollektivvertrag)? Agreement with union or works council necessary.

• Bad motivational effects on workers

• Best workers feel mistreated and leave


Downsizing, laying off workers

• Probably better for morale of remaining workers– If necessity of downsizing is communicated and

understood – If the right workers are laid off– If the laid off workers are treated well

• Advance notice• Redundancy plan with severance pay, outplacement assistance,

etc. Example: Linzer Stahlstiftung

• In many cases, firms use business cycle downturns to get rid of workers they do not want anymore (for different reasons).


Who should the firm lay off?

• PV(all future earnings) > PV(future productivity)– PV is present discounted value

– 1. General human capital • Workers are paid according to productivity: does not matter who to

lay off (as long as there is no production constraint)

– 2. Firm-specific human capital

Who to lay off?• Young workers with little investment

• Older workers whose high productivity lies in the past


Firm-specific HC case

• Assume: PV(Earnings) = PV(Productivity)

over total career– V(t) productivity– W(t) wage– A(t) outside option

• Difference between V(t) and W(t) is greatest for people in middle of career

A(t)

W(t)

V(t)

V(t)=value of productivityw(t)=wageA(t)=value of worker's time

Time

V,A

, W

Career with firm


Who should the firm lay off?

• Now there are unforeseen changes: productivity declines to V(t) – E.g. price of the good declined

• Keep people who are in the middle of their career!

• Is selective lay-off of older workers possible considering legal, motivational issues, etc.?

A(t)

W(t)

V(t)

V(t)=value of productivityW(t)=wageA(t)=value of worker's time

Time

V,A

, W

V(t)


55200 38640 111414 260588 182412


PV(W) <=PV(V) ?PV(W) <=PV(βV) ?

12727412724 > 125706

57 J


57J: PV(W) > PV(βV) PV(βV) – PV(W) = -1568

57J: PV(A) + 1568 > PV(W)

62J: PV(W) > PV(βV) PV(βV) – PV(W) = -16 944

62J: PV(A) + 16944 < PV(W)PV(A) + 16944 = PV(W) + 1672


Who should the firm buyout?

• Only the older workers, why?• Buyout of a workers is possible if:

PV(βV(t)) < PV(A(t)), because– buyout is profitable for firm if buyout costs are less than what

would be lost on the worker: PV(W(t)) – PV(β V(t)) > B– worker accepts buyout B if the deal is better than the old wage

stream: B + PV(A(t)) ≥ PV(W(t)) – both conditions are fulfilled if PV(V(t)) < PV(A(t))

• The better the worker’s alternatives, the easier it is to buy her out.

• The lower the output in the current firm, the more eager is the firm to buyout.


How to calculate actual buyout offers?

• Data needed for age groups:

– Productivity path– Wage profile– Alternative wage (utility)


How to buyout?

• Buyout costs are lowest, the closer the worker is to retirement

• Reverse age-buyout relation: you want to offer a higher buyout payment to less senior workers (contrary to seniority-based pay) – Solution: Offer pre-retirement pay; i.e. for each additional year

until regular retirement age an additional amount of payment is offered.

• Job placement services may be a good strategy: reduce the cost of buyout


How to buyout?

• Workers with more firm-specific human capital (e.g. employees with direct contact to long-term customers) demand a higher buyout payment because their relative outside options are poorer.

• Low productivity people may be worth less to the firm if there is wage compression, but high ability people will have more outside opportunities, so you get adverse selection with an across the board buyout scheme!

• Is it possible to make a worker-specific buyout plan?You can make an offer in kind which is appealing only for certain types of workers: e.g. extensive job search assistance or retraining, which only the least productive workers find attractive.


Incentive Effects

• If buyouts are offered to low ability people only, high ability people have incentives to shirk.

• To avoid the incentive problem unanticipated buyout offers may be necessary.

• The firm may also want to buyout younger workers rather than laying them off if reputation is an issue.

Personnel Economics 7 1 Chapter 7: Turnover, Layoffs and Buyouts Is turnover always bad? Which...

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