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)?
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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)
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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
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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
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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
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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
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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).
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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
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Firm-specific HC case
– 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
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A(t)
V,A, W
• Assume:
PV(Earnings) =
PV(Productivity)
over total career
W(t)
V(t)
V(t)=value of productivity
w(t)=wage
A(t)=value of worker's time
Time
Career with firm
9
Who should the firm lay off?
• Now there are unforeseen
changes: productivity
declines to bV(t)
– E.g. price of the good declined
• Is selective lay-off of older
workers possible considering
legal, motivational issues,
etc.?
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A(t)
V,A, W
• Keep people who are in the
middle of their career!
W(t)
V(t)
V(t)=value of productivity
W(t)=wage
A(t)=value of worker's time
bV(t)
Time
10
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55200
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38640
111414
260588
182412
12
PV(W)
PV(W) <=PV(V)
<=PV(βV)? ?
127274
12724 > 125706
57 J
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57J:
PV(W) > PV(βV)
62J:
> PV(βV)
PV(βV)PV(W)
– PV(W)
= -1568
PV(βV) – PV(W) = -16 944
+ 16944
< PV(W)
57J: 62J:
PV(A)PV(A)
+ 1568
> PV(W)
PV(A) + 16944 = PV(W) + 1672
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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.
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How to calculate actual buyout
offers?
• Data needed for age groups:
– Productivity path
– Wage profile
– Alternative wage (utility)
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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
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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.
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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.
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