2.3 Probation, promotion and internal labor market

1. Probation time

2. Internal labor market

• There are two types of workers: qualified and under-qualified. Which type a given worker belongs is known to the worker but unknown to the firm.

• The firm decides to hire workers for a probationary period. If a worker fulfills the probation requirements, he is promoted (or employed further). If not, he is fired.

• Model parameters:

  • 𝑤𝑞, 𝑤𝑢 are alternative incomes for the qualified and under-qualified workers during the probation period, 𝑤𝑞 > 𝑤𝑢.

  • 𝑝 is the probability that the under-qualified worker will pass the probation requirements.

• Model assumptions:

  • The lengths of the probation and post-probation periods are the same.

  • There is no discounting.

The following conditions are sufficient to determine 𝑤1, 𝑤2

1s. Probation is profitable for qualified workers: 𝑤1 + 𝑤2 ≥ 2𝑤𝑞.

2s. Probation is not profitable for under-qualified workers: 𝑤1 + 𝑝𝑤2 + (1 − 𝑝)𝑤𝑢 < 2𝑤𝑢.

—>Solving conditions 1s. and 2s. simultaneously for 𝒘𝟏,𝒘𝟐 gives the range of 𝑤1, 𝑤2 that will attract qualified workers and discourage under-qualified ones. This range can be empty, which means probation is not feasible.

ILM is a type of employment relationship involving:

• Long-term (possibly indefinite) contract between employer and employee

• Long-term relationship between the firm and the worker

• Promotion from within firm and Promotion linked to on-the-job training and specific skills acquisition

• Formal rules and procedures governing employment, promotion and pay (thus pay is not necessarily market-based)

• Emphasis on seniority.

  
  

benefits of ILM:

• Improves screening: the reliability of performance indicators increases with observation time.

• Good for employee loyalty, commitment and team spirit.

• Supports incentives related to promotion and job security.

• Economies of scale on staffing costs.

• Needed to support the acquisition of firm-specific skills by the workers, who would otherwise have little incentive to do so.

costs of ILM:

• Long-term obligations implied by ILM (job security, seniority pay, benefits) may be expensive.

• Lack of flexibility and diversity.

• Bureaucratic inefficiencies.

ILM and screening

• Hiring from within the firm gives access to more and better information about a candidate than can be obtained from the outside. This leads to more efficient screening.

• All else equal, promotion through ILM is increasingly preferred to hiring from outside as the value of the job and the costs of making a wrong decision increase.

  —>Evidence of more ILM promotions, and fewer external hires, at higher levels of organizational hierarchy

Data:

White-collar workers in Sweden changing jobs in 1988. Table 5 in: Source: Lazear and Oyer (2004) Internal and external labor markets: a personnel economics approach. Labour Economics, 11: 527-554