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Layoffs as Part of an Optimal Incentive Mix: Theory and Evidence

  • Anders Frederiksen

    ()

    (Stanford University)

  • Elõd Takáts

    ()

    (Princeton University)

Firms offer highly complex contracts to their employees. These contracts contain a mix of various incentives, such as fixed wages, bonuses, promise of promotion, and threat of firing. This paper aims at explaining the reason why this incentive- mix arises. In particular, the model focuses on why firms are combining promotions and bonuses with firing. The theoretical model proposed is a job-assignment model with heterogeneous employees. In this model the firm is concerned about job assignment, because the overall productivity of the firm depends upon the quality of the employees and their allocation to jobs. The model shows that firing has a dual role. Firing creates incentives for the employees, and it is used as a sorting device that allows the firm to improve workforce quality. Thus, quality-concerned firms might want to combine cost-efficient incentives such as promotions and bonuses with firing. To comply with the Gibbons and Waldman critique, a large set of the model’s broader predictions is stated explicitly and tested on the personnel records from a large pharmaceutical company. The model’s predictions are shown to be consistent with the data.

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File URL: http://english.mnb.hu/Root/Dokumentumtar/MNB/Kiadvanyok/mnbhu_mnbfuzetek/mnbhu_wp2006_2/wp2006_2.pdf
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Paper provided by Magyar Nemzeti Bank (the central bank of Hungary) in its series MNB Working Papers with number 2006/2.

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Length: 39 pages
Date of creation: 2006
Date of revision:
Handle: RePEc:mnb:wpaper:2006/2
Contact details of provider: Web page: http://www.mnb.hu/

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  1. Shapiro, Carl & Stiglitz, Joseph E, 1984. "Equilibrium Unemployment as a Worker Discipline Device," American Economic Review, American Economic Association, vol. 74(3), pages 433-44, June.
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  19. Gibbons, Robert & Waldman, Michael, 1999. "Careers in organizations: Theory and evidence," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 36, pages 2373-2437 Elsevier.
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