Promotions, Demotions, Halo Effects, and the Earnings Dynamics of American Executives

Abstract

This paper explores the dynamics of wage growth in corporate hierarchies. Using panel data techniques, we estimate the causal effect of current and past transitions in reporting level and past earnings growth on components of current earnings and earnings growth using a large panel of US executives. After conditioning on unobserved heterogeneity, current compensation growth is positively correlated with past promotion outcomes but negatively correlated with past compensation growth. In a flexible model of wage growth, there is an important asymmetry between the effect of a promotion and a demotion. The effect of promotion is smaller in magnitude than the effect of a demotion. The causal effect of a promotion is positive on * We thank Bentley MacLeod, Thomas Dohmen, Peter Mueser, Zhong Zhao and seminar participants at IZA and at the 2005 SOLE/EALE Meetings in San Francisco. The support of a Marie Curie Fellowship for the Transfer of Knowledge is gratefully acknowledged by Bognanno. 1 both growth in base pay and total cash compensation but is negative on bonus growth. The effect of a demotion is negative on growth in all pay components.JEL Classification: C33, J41, M5, M51 2 IntroductionThe correlation between earnings growth and promotion is well accepted in the personnel economics literature. 1 The statistical analysis of this relationship is typically confined to descriptive statistics, correlations or standard linear regression techniques that do not address selectivity and endogeneity issues. For this reason, economists should be reluctant to give a causal interpretation to the results that have emerged in the literature. As the evolving personnel economics literature is clarifying and adding detail to aspects of pay and promotion in internal labor markets largely through new case studies, a valuable contribution at this point would be to address the issues of unobserved individual heterogeneity and the endogeneity of transition indicators (promotion and demotion). This requires the use of static and dynamic panel data techniques. This paper studies the dynamics of wage growth in corporate hierarchies. With a focus on internal labor markets, it may be viewed as contributing to the research in personnel economics, as well being part of a larger literature on wage growth. Part of the contribution to the wage growth literature is the ability to examine the role played by intrafirm mobility in wage dynamics. In regards to personnel economics, this paper addresses some of the fundamental questions that have been posed by theoreticians in the field. In Lazear's Presidential Address to the Society of Labor Economists [1999], he suggests new areas for research in personnel economics including the effect of past success on current wage growth (the halo effect) and the effect of the business environment on current wage growth. We find evidence of halo effects resulting from past promotion and find that changes in firm profitability have an effect on compensation growth through the bonus component.In line with t...

Worker mobility in a search model with adverse selection

“…In the calibration larger (pooling) firms have a 2% higher internal mobility rate (defined as promotions and demotions relative to employment) than smaller (separating) firms, which is consistent with the evidence obtained by Idson (1989). 34 Alongside this result, we also find that workers in smaller (separating) firms have 32 Consistent with Gibbs et al (2002) and Belzil and Bognanno (2008), demotions in our model are accompanied by pay cuts and by subsequent increases in job-transition probabilities.…”

“…Given that one tends to consider demotions as infrequent events, this number might seem low. However, Belzil and Bognanno (2008), analyzing a survey of executives in U.S. firms, find that within-firm promotions are only slightly more frequent than demotions. 27…”

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“…The part-time wage gap may also evolve during workers' career progression, in fact, wage changes around promotions are substantial (Baker et al 1994, Booth et al 2003, Belzil and Bognanno 2005. 3 2 In the presence of fixed labor costs (such as hiring and training costs) firms may be able to equalize labor costs across part-time and full-time jobs.…”

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“…The internal labor market literature finds a similar convexity of earnings (Belzil and Bognanno, 2008).…”

“…These administrative rules can induce pay compression, and their structure usually results in larger wage increases for those at the bottom of the wage distribution in a given job level, and smaller raises for those at the top. Baker et al (1994a) provide evidence of 'green card' effects by showing that, within a given job level, those in higher salary quartiles earn lower percentage raises (see also Belzil and Bognanno, 2008). more promotion lags.…”