On the trade-off between efficiency in job assignment and turnover: The role of breakup fees

Publication Type:
Journal Article
Journal of Law, Economics, and Organization, 2018, 34 (2), pp. 230 - 271
Issue Date:
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© The Author(s) 2018. We highlight a novel trade-off with the use of breakup fees in employment contracts. Under asymmetric learning about workers productivity, the market takes job assignments (or promotions) as a signal of quality and bids up the wages of a promoted worker, leading to inefficiently few promotions (Waldman, M. 1984. Job Assignments, Signalling, and Efficiency 15 RAND Journal of Economics 25567). Breakup fees can mitigate such inefficiencies by shielding the firm from labor-market competition, but they reduce turnover efficiency when there are firm-specific matching gains. We show that it is optimal to use breakup fees if and only if the difference between the worker's expected productivity in the pre- and post-promotion jobs is small. Also, the relationship between the optimality of breakup fees and the importance of firm-specific human capital is more nuanced than what the extant literature may suggest. (JEL D82, M5).
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