Working Paper: CEPR ID: DP8831
Authors: Emmanuelle Auriol; Guido Friebel; Frauke Lammers
Abstract: We suggest a parsimonious dynamic agency model in which workers have status concerns. A firm is a promotion hierarchy in which a worker?s status depends on past performance. We investigate the optimality of two types of promotion hierarchies: (i) internal labor markets, in which agents have a job guarantee, and (ii) 'up-or-out', in which agents are fired when unsuccessful. We show that up-or-out is optimal if success is difficult to achieve. When success is less hard to achieve, an internal labor market is optimal provided the payoffs associated with success are moderate. Otherwise, up-or-out is, again, optimal. These results are in line with observations from academia, law firms, investment banks and top consulting firms. Here, up-or-out dominates, while internal labor markets dominate where work is less demanding or payoffs are more compressed, for instance, because the environment is less competitive. We present some supporting evidence from academia, comparing US with French economics departments.
Keywords: incentives; promotion hierarchies; sorting; status
JEL Codes: J3; L2; M5
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| up-or-out systems are optimal when success is difficult to achieve (L21) | promotion hierarchy is optimal (L21) |
| internal labor markets are optimal when success is easier and payoffs are moderate (F16) | promotion hierarchy is optimal (L21) |
| variance in career success is lower in internal labor markets compared to up-or-out systems (J62) | variance in career success (D29) |
| workers' status concerns (J83) | workers' behavior and productivity (J29) |
| juniors work harder in up-or-out systems compared to internal labor markets (J62) | effort levels of juniors (D29) |