Wage Trends as Performance Displays Productive Potential: A Model and Application to Academic Early Retirement

Abstract

Wage trends over the working career are explored in a two-period model assuming that workers have different intrinsic productivities which are manifested stochastically. Firms compete for a limited number of risk averse employees. The basic model, which was developed for the study of academic research employment, postulates that information on prospective productivity is symmetrically available to firm and worker. The observed pattern of academic wages is found to emerge: young faculty is underpaid and the less well paid older faculty is overpaid. The model is used to investigate early retirement plans intended to induce the latter group to retire. It is found that such plans can only be economically advantageous if the prorated overhead costs of a faculty member exceed the value of his output. The basic model is then reinterpreted to answer the general question: when and how should a firm discharge employees of low productivity? A contrasting asymmetrical information model is also introduced (employees have more information than employers). In the asymmetrical case, the composition of the labor force is endogenously determined by self-selection of prospective employees. Firing of employees with poor track records can also occur.