Academic journal article Economic Inquiry

External Recruitment and Intrafirm Mobility

Academic journal article Economic Inquiry

External Recruitment and Intrafirm Mobility

Article excerpt

I. INTRODUCTION

Competition for promotion has a very strong effect on employees' work incentive. In the stereotypic internal labor market described in Doeringer and Piore (1985), there are only a limited number of ports of entry into a hierarchical firm or organization, so that existing employees are insulated to a large extent from external competition in their climb up the corporate ladder. However, Lazear (1992) and Baker et al. (1994a, 1994b) find extensive external recruitments at almost all grade levels in their studies of different U.S. corporations. If the boundary between internal and external labor markets is not impervious, then the choice between external recruitment and internal promotion in filling openings becomes an important personnel decision, with interesting implications on incentives.

Opening up the competition to external applicants discourages collusion among candidates as well as offers a quick channel for absorbing external talents. However, it also reduces the probability of promotion for existing workers and thus their incentive to exert, with adverse effect on the firm's profit. In Chan (1996), I suggest that work incentive for the internal promotion candidates can be maintained if external competitors are handicapped in the contest. Such favoritism for existing employees implies that senior positions tend to be filled internally more often than not, and that a worker is recruited from the outside only if he or she demonstrates a significant margin of superiority over the internal candidates. This is consistent with the observations that external recruits account for only about 15% to 20% of all appointments to top management positions (see Denis and Denis 1995; Warner et al. 1988) and that roughly the same percentage of chief executive officers (CEOs) of large U.S. firms are outsiders (see Agrawal et al. 2002; Chan 1996; Parrino 1997).

The "handicapping" hypothesis of promotion suggests a dilemma in personnel decisions. Although handicapping external applicants provides incentive for existing employees, it also increases the chance of inferior internal contestants being promoted to senior positions. Where sorting of workers by ability into different (particularly senior) positions is important, efficiency within the organization is compromised. This tension between sorting and maintaining work incentive is explored in Tsoulouhas et al. (2001). Unfortunately, the gain in realism with the incorporation of sorting is offset by ambiguity in most of the results. The ability of the firm to precommit to future compensation, the relative abilities of the internal and external contestants, the cost of work effort, and commonality within the firm and within the industry all have a role in determining the direction and magnitude of the handicap, with different combinations of these factors resulting in very different outcomes.

Whether one starts with the Chan model or the Tsoulouhas model, empirical evidence is important to establish the significance of the competitive handicap against external candidates. There has been no shortage of empirical investigations of the incentive effects of tournaments. Most follow one of two different analytic approaches. One approach uses cross-sectional or nonpanel data, such as data on executive salary across firms (Gibbons and Murphy 1990; Leonard 1990; Main et al. 1993) or data from professional sports tournaments (see, for example, Ehrenberg 1990); few of these studies address the distinction between internal or external contestants. Agrawal et al. (2002) is an exception. It tests implications of the handicapping hypothesis derived in Tsoulouhas et al. (2001) by analyzing more than 1,000 CEO successions in large U.S. firms from 1974 to 1995. Even though some of the results are also consistent with a traditional human capital interpretation, and the key hypothesis can be derived from the Tsoulouhas model only under certain conditions, they offer some support for the existence and relevance of the competitive handicap against external contestants. …

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