A new paper in the American Economic Review presents a formal model of why top professional firms hire very capable people, train them intensively, and then allow many to leave. The authors—two financial economists from the University of Rochester and the University of Wisconsin–Madison—focus on occupations where individual performance is observable and can be linked to the person.
The model views elite firms as intermediaries that hire workers and sell their services to clients. At the start clients cannot judge a new hire’s ability well, but the firm can observe and measure talent more accurately. During what the authors call “quiet periods,” firms retain employees who perform adequately and pay standard wages while they gather performance data.
Over time public measures of performance—such as winning cases, profitable investments, or successful projects—reduce the firm’s informational edge. As clients observe results, they update beliefs about specific workers. When the information gap narrows, firms must choose between paying some employees more or letting some leave and keeping others at lower pay; by letting workers go, firms can increase what they extract from those who stay.
The researchers argue that this selective churning can benefit both sides: remaining employees accept lower pay temporarily to build a strong reputation and later can charge higher fees, while early leavers still signal ability through their prior affiliation. The model implies a stable equilibrium in which turnover and selective retention manage information and profits and the market gradually identifies top-tier workers.
- Law
- Consulting
- Fund asset management
- Auditing
- Architecture
Difficult words
- intermediary — a firm that acts between workers and clientsintermediaries
- retain — to keep someone in a job or position
- informational — about knowledge that affects decisions
- update — to change beliefs or information with new data
- reputation — general opinion people have about someone's ability
- turnover — rate at which employees leave and are replaced
- selective — choosing only some people or things
- extract — to take value or profit from someone or something
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Discussion questions
- What risks and benefits face workers who accept lower pay temporarily to build a reputation at an elite firm?
- How does increased public observation of performance change the relationship between firms, workers, and clients?
- Which other professions could follow the same model of hiring, training, and selective turnover? Give reasons.
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