1. Personnel Economics 7 1 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)?

2. Personnel Economics 7 2 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)

3. Personnel Economics 7 3 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

4. Personnel Economics 7 4 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

5. Personnel Economics 7 5 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

6. Personnel Economics 7 6 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

7. Personnel Economics 7 7 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).

8. Personnel Economics 7 8 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

9. Personnel Economics 7 9 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 productivity w(t)=wage A(t)=value of worker's time Time V,A, W Career with firm

10. Personnel Economics 7 10 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 productivity W(t)=wage A(t)=value of worker's time Time V,A, W  V(t)

11. Personnel Economics 7 11

12. Personnel Economics 7 12 5520038640111414260588182412

13. Personnel Economics 7 13 PV(W) <=PV(V) ? PV(W) <=PV(βV) ? 12727412724 > 125706 57 J

14. Personnel Economics 7 14 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

15. Personnel Economics 7 15

16. Personnel Economics 7 16 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.

17. Personnel Economics 7 17 How to calculate actual buyout offers? Data needed for age groups: –Productivity path –Wage profile –Alternative wage (utility)

18. Personnel Economics 7 18 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

19. Personnel Economics 7 19 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.

20. Personnel Economics 7 20 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.