Chapter 7: Turnover, Layoffs and Buyouts

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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 firms 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) gt 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

• 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

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Who should the firm lay off?

• Now there are unforeseen changes productivity
  declines to bV(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.?

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55200
38640
111414
260588
182412
13
PV(W) ltPV(V) ?
PV(W) ltPV(ßV) ?
127274
12724 gt 125706
57 J
14
57J PV(W) gt PV(ßV) PV(ßV) PV(W) -1568
62J PV(W) gt PV(ßV) PV(ßV) PV(W) -16 944
57J PV(A) 1568 gt PV(W)
62J PV(A) 16944 lt 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(ßV(t)) lt 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(ß V(t)) gt 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)) lt
  PV(A(t))
• The better the workers 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.