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Responding to Regulation: The Effects of Changes in Mandatory Retirement Laws on Firm-Provided Incentives

Author

Listed:
  • Frederiksen, Anders

    (Aarhus University)

  • Flaherty Manchester, Colleen

    (University of Minnesota)

Abstract

The Age Discrimination in Employment Act of 1978 expanded employee age protections to age 70, making the widespread practice by U.S. firms of mandating retirement at age 65 illegal. Building on the work of Lazear (1979), we propose that the law change not only weakened the long-term employment contract, but also contributed to the rise in pay-for-performance incentives. We model the firm's choice between offering long-term incentive contracts with low monitoring requirements and pay-for-performance (PFP) contracts with high monitoring requirements, showing how the law change increased the relative attractiveness of PFP contracts. We test the model's predictions using data from the Baker-Gibbs-Holmstrom firm, evaluating the effect of the law change on the slope of the age-pay profile, turnover rates, and the sensitivity of pay to performance. Further, we find direct evidence of strategic response to the law change by the firm, including the introduction of bonus payments, change in performance management system, and increase in the proportion of top managers. The setting also provides an opportunity to empirically investigate how firms navigate career incentives for employees.

Suggested Citation

  • Frederiksen, Anders & Flaherty Manchester, Colleen, 2019. "Responding to Regulation: The Effects of Changes in Mandatory Retirement Laws on Firm-Provided Incentives," IZA Discussion Papers 12264, Institute of Labor Economics (IZA).
  • Handle: RePEc:iza:izadps:dp12264
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    References listed on IDEAS

    as
    1. Frederiksen, Anders & Lange, Fabian & Kriechel, Ben, 2017. "Subjective performance evaluations and employee careers," Journal of Economic Behavior & Organization, Elsevier, vol. 134(C), pages 408-429.
    2. George Baker & Michael Gibbs & Bengt Holmstrom, 1994. "The Wage Policy of a Firm," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 921-955.
    3. Lisa B. Kahn & Fabian Lange, 2014. "Employer Learning, Productivity, and the Earnings Distribution: Evidence from Performance Measures," Review of Economic Studies, Oxford University Press, vol. 81(4), pages 1575-1613.
    4. Lazear, Edward P, 1986. "Salaries and Piece Rates," The Journal of Business, University of Chicago Press, vol. 59(3), pages 405-431, July.
    5. Edward P. Lazear, 2000. "Performance Pay and Productivity," American Economic Review, American Economic Association, vol. 90(5), pages 1346-1361, December.
    6. Gibbons, Robert & Murphy, Kevin J, 1992. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," Journal of Political Economy, University of Chicago Press, vol. 100(3), pages 468-505, June.
    7. Bishop, John, 1987. "The Recognition and Reward of Employee Performance," Journal of Labor Economics, University of Chicago Press, vol. 5(4), pages 36-56, October.
    8. Lazear, Edward P, 1979. "Why Is There Mandatory Retirement?," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1261-1284, December.
    9. Edward P. Lazear & Robert L. Moore, 1984. "Incentives, Productivity, and Labor Contracts," The Quarterly Journal of Economics, Oxford University Press, vol. 99(2), pages 275-296.
    10. George Baker & Michael Gibbs & Bengt Holmstrom, 1994. "The Internal Economics of the Firm: Evidence from Personnel Data," The Quarterly Journal of Economics, Oxford University Press, vol. 109(4), pages 881-919.
    11. Michael Gibbs & Wallace Hendricks, 2004. "Do Formal Salary Systems Really Matter?," ILR Review, Cornell University, ILR School, vol. 58(1), pages 71-93, October.
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    More about this item

    Keywords

    slot constraints; promotions; long-term incentive contracts; pay for performance; incentive pay; career incentives;
    All these keywords.

    JEL classification:

    • M51 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Firm Employment Decisions; Promotions
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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