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Journal of Law, Economics, and Organization Advance Access published online on August 3, 2009
Journal of Law, Economics, and Organization, doi:10.1093/jleo/ewp017
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© The Author 2009. Published by Oxford University Press on behalf of Yale University. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Promotions, Dismissals, and Employee Selection: Theory and Evidence

Anders Frederiksen*

Aarhus University

Elod Takáts**

International Monetary Fund

* Department of Marketing and Statistics, Aarhus School of Business, Aarhus University. Email: afr{at}asb.dk.

** International Monetary Fund. Email: etakats{at}imf.org.

Firms offer highly complex contracts to their employees. These contracts contain a mix of incentives, such as fixed wages, bonus payments, promotion options, and dismissals or threats of dismissal. In this article, we show that firms having a production process that is sensitive to employee quality may find it optimal to combine cost-efficient incentives such as bonuses and promotions with dismissals. Based on this result, we derive a hierarchy of incentives. Furthermore, we demonstrate the close link between the optimal contract and the employee sorting and selection and use this to analyse the information conveyed in employment matches. (JEL J30, J41, M50)

This research project has been supported financially by The Danish Social Science Research Council through a grant to Center for Corporate Performance (CCP). Elod Takáts is grateful for financial support from the Gregory C. Chow Econometric Research Program. Anne Raaby Olsen has provided valuable research assistance.


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