The dynamics of promotions, quits and layoffs

Which manager should a firm promote to CEO? How do the attributes of a managerial workforce affect firms’ placement decisions and wage offers, and managers’ quit decisions? The existing literature offers trivial answers to this nuanced question. In one class of models, placement decisions are determined on an individual-by-individual basis, so that promotion of one worker does not crowd out another. In the other class — rank order tournaments — the answer is simply the manager who is believed to be most able. The real world is far more complicated, as the firm-wide distribution of all managerial attributes — including ability, age and complementarities — enters the placement/wage decisions by firms and the quit decisions by managers. This paper develops a rich dynamic model to get at these issues. Our OLG model features two division managers and a CEO, where each executive may be at a different point in his employment horizon. Taking into account the attributes of all executives, the firm decides which manager to promote to CEO, which manager(s) to lay off, and what wage offers to make to different executives; while managers who were not laid off decide whether to stay at the firm or to quit and take an outside employment offer. We analyze how the decisions of the firm and managers vary according to the age-skill profiles of the firm’s executives. We provide sufficient conditions for the existence of a unique equilibrium, in which: (i) the firm has a bias toward promoting older managers to CEO, even in the absence of learn-bydoing; (ii) the firm’s strategy is monotone on manager’s own skill, so that if a manager of a given age/ability is promoted, then so are more able managers of the same age, but (iii) the firm’s strategy is a complex, possible non-monotonic function of the attributes of other executives; (iv) a middleaged manager is more likely to stay at the firm when the other manager is older or sufficiently less talented, and when (v) the CEO is older. We then characterize how the firm trades off between wages and placement offers to align managerial incentives. In particular, the firm uses the flexibility in wage offers to “smooth” the discrete incentives generated by placement offers.