Turnover, Layoffs, Buyouts

1
Chapter 4

• Turnover, Layoffs, Buyouts

2
Reading for next class

• http//valleywag.gawker.com/374442/its-april-1-and
  -i-dont-know-what-my-salary-is

3
Question from CNN Money reading

• The article argues that taking a buyout offer
  from a firm (and retiring early instead of
  staying on) is
• A. Usually a bad idea, except if firm is about to
  lay off workers
• B. Usually a good idea, except if firm is growing
• C. The article takes no stand
• The enticements you'll get to retire early
  likely won't offset the drawbacks of spending
  fewer years at the office
• Nonsense
• 60 of workers find other jobs after taking the
  buyout
• Value of leisure
• Invalidates the whole argument

4
Clip

• http//www.nbc.com/The_Office/video/clips/branch-c
  losing/116285/

5
Opinion Poll

• Are lay-offs wrong?
• A. Yes
• B. No

6
Opinion Poll

• Would it be better to lower all workers wages
  than to lay off some workers?
• A. Yes
• B. No

7
Opinion Poll

• If lay-offs must occur, who should be laid off?
• A. Older workers
• B. Younger workers
• C. Both
• D. Pick randomly

8
Chapter Themes

• When is turnover (quitting or layoffs) good for a
  firm?
• Which groups should be targeted?
• How do existing laws influence the
  decision-making process?
• When and how to buy out older workers?
• How to avoid adverse selection in turnover?

9
When is Turnover Good for a Firm?

• When combination of workers by skill not profit
  maximizing.
• Example Workers by age.
• Older workers have more firm-specific skill
• Younger workers, more recent ed., more technology
  savy.
• With fixed number of older workers, hiring more
  younger workers increases output at diminishing
  rate.
• (Works both ways).
• Could have wrong mix

Qyoung

Qold
10
Factors that Favor Younger Workers

• Rapid tech change
• Most H.C. is attainable through schooling, not
  OJT
• Firm does not need much firm-specific capital
• Not quirky

Qyoung

Qold
11
What Makes Firm Alter its Mix?

• Factors
• Change in technology
• Change in demand for product
• Change in prices of inputs
• Flexible firms survive
• Non-flexible firms fail
• Both worker and firm lose when firm fails

Qyoung

Qold
12
When firm needs to downsize, whom to lay off?

• Most firms have some firm-specific H.C.
• Initially firms lose money while subsidizing
  training
• Later, make profits each year because VMPgtwage.
• Rule
• Firms want to keep worker if PDV of rent (gap
  between VMP and wages) gt0.

13
Analysis

• Definitions
• VtVMP(t)
• Wtwage paid to worker.
• Tretirement age
• tcurrent age
• rinterest rate
• Initially, firm loses money
• WtltVt
• Later firm earns profit
• VtgtWt
• Rent to firm for keeping worker from t until T
  is

Wt
Vt
t
T
14
Question

• Example R7
• In the Figure, what appears to be true of the
  firms rent at time t7, R7
• A. R7gt0
• B. R7lt0
• C. R70

Wt
Vt
t
7
T
15
Rents

• Note 1 R00. Why?
• Must pay worker what she is worth or similar
  firms steal worker and still make profit
• Note 2 RT0. Why?
• Invest initially, then get all of it back.
• By the last instant of the last period, there is
  nothing left to get back.
• (epsilon maybe)

Wt
Vt
t
T
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Worker Alternative

• Worker has alternative options,outside the firm
• AtValue at t of best outside option
• Generally this rises over time
• Leisure more valuable when older.
• Retirement, fishing, etc.

At
Wt
Vt
t
T
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Graph of Rents

• R00
• Rt rising as worker gets trained
• Already have some investment in worker, fewer
  periods of losses remain
• Rt peaks as worker is fully trained
• Only surplusses remain
• Rt falls in later years
• Fewer and fewer years of surplusses left
• RT0

At
Wt
Vt
t
T
Rt
t
0
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What Happens if Demand for Firms Product Falls?

• Vt? at every pnt in time
• Rt ? at every pnt in time so
• Some workers now have negative rents
• Whom do you lay off?
• A. Oldest workers
• B. Youngest workers
• C. Both
• D. Neither
• E. Can tell
• Makes sense to lay offoldest and youngest
• Lowest rents

At
Wt
Vt
Vt
t
T
Rt
t
0
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Legal Considerations

• Age discrimination act
• Prohibits firms from laying off based on age
• Protects workers gt40
• Upshot Cant be seen to lay off oldest workers
  first
• Continental Can sued for 100s of millions of
  dollars.
• Sidebar Law make sense?l
• Why not lower wages to reflect lower VMP?
• Contractual arrangement
• Veiled attempt to fire
• Workers dont like it

At
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Vt
t
T
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t
0
20
Buyouts

• If you cant fire older workers, buy them out.
• A buyout is an offer made to worker of specific
  age to retire early in exchange for severance pay
  
• Voluntary
• Pay them to go away.
• Rule
• Buyout when PV of workers alternative gt PV of
  productivity.

21
Buyouts Analysis (Workers)

• Worker accepts buyout if BPV(At)gtPV(Wt)
• Bgt PV(Wt)-PV(At)
• Example Workers will accept buyout if
• Bgtarea of small green triangle

At
Wt
Vt
Vt
t
T
Rt
t
0
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Buyouts Analysis (Firms)

• Firm offers buyout ifBltPV(Wt)-PV(Vt)
• Note This assumes PV(Wt)gtPV(Vt).
• Example Firm will want to buy out workers if
• Bltarea of small blue triangle

At
Wt
Vt
Vt
t
T
Rt
t
0
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Buyouts Analysis (Workers and Firms)

• Firm offers if
• BltPV(Wt)-PV(Vt)
• Worker accepts if
• BgtPV(Wt)-PV(At)
• When both conditions holdPV(Wt)-PV(At)ltBlt
  PV(Wt)-PV(Vt)
• -PV(At)lt -PV(Vt)
• PV(At)gtPV(Vt)
• Intution If what firm is losing on me is bigger
  than what I lose by choosing my next best job,
  firm can pay me to quit and were both better off

At
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t
T
Rt
t
0
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Buyouts Notes

• Who least suited for buy-out?
• Workers with lots of firm specific capital.
• More valuable at the firm than elsewhere.
• Low alternative options
• High prody.
• What about most productive workers?
• They may cost more.
• May be more productive elsewhere
• Sometimes these should be bought out.
• PV(At) high.

At
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Vt
Vt
t
T
Rt
t
0
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Opinion Poll

• Buyout offered for 5 years. You decide to wait
  for a while to take buyout. In the meantime, do
  you
• A. Try to be extra productive
• B. Try to be unproductive
• C. Make no change in effort

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Moral Hazard

• What happens if you have a buyout plan available
  for 5 yrs?
• Worker acts unproductive so hell get generous
  buyout plan
• This is moral hazard or hidden action problem
• Solution Window plan. (Small time interval)

At
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Example

• Universities didnt want old tired professors
• Solution adopted Universities offered early
  retirement incentives to older faculty.
• Who took early retirement?
• A. Productive professors
• B. Unproductive professors
• C. Cant tell

28
Example

• The most able professors took early retirement
  packages, got jobs at other universities.
• Professors who stayed were the ones no one else
  would hire
• The ones they wanted to stay left, and the ones
  they wanted to leave stayed!
• Classic problem of adverse selection!

29
How to fix?

• Make retirement package more generous for less
  productive researchers.
• If youre bad at your job, well pay you a lot to
  leave early.
• If youre good at your job, we wont pay you much
  to leave early.
• Problem. Could be unpopular. Looks like punishing
  workers for being productive!
• How to get around this?

30
Question

• As drawn, who requires a larger buyout to be
  willing to leave?
• A. 64 year old workers
• B. 60 year old workers
• C. Cant tell

At
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Vt
t
T
60
64
Rt
t
0
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Question

• In CNN reading, we learned that buyouts often
  offer a sweetened pension, with as much as five
  years added to your age and job tenure.
• Say, full pension kicks in at 65. Who gets the
  bigger marginal gain from the buyout offer
• A. The 64 year old worker who gets a sweetened
  pension and is treated as if he were 65.
• B. The 60-year old worker who gets a sweetened
  pension and is treated as if he were 65
• Better deal if you are younger!

32
Adverse Selection

• You want to offer different buyout plans for
  different workers
• 64 year old worker will take low buyout
• 60 year olds require more
• How to offer more to the workers you want to
  quit?
• Law makes it hard to offer more to 60 than 64
  year olds.
• Retirement bridge.
• Means extra pension benefits the younger you are
• Example CNN reading

At
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60
64
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Review

34
Lifecycle graph

• Drawing lifecycle wages and productivities

At
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t
35
Question 1

• At which instant in time (A, B, C, D, or E) would
  the worker be earning the most profit for the
  firm?

At
Wt
Vt
B
C
D
A
E
t
36
Question 2

• At which point in time is the total rent the
  firm gets for keeping the worker largest?

At
Wt
Vt
B
C
D
A
E
t
37
Question 3

• At which point in time (A, B, C, D, or E) is the
  worker unwilling to work?

At
Wt
Vt
B
C
D
A
E
t
38
Other strategies

• Some firms offer job placement programs to
  workers facing buyouts
• Are these firms being completely unselfish?
• A. Probably
• B. Probably not

At
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Vt
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T
60
64
Rt
t
0