Wage policy, employee turnover and productivity

In this paper, we are interested in the effect of pay incentives on labour turnover and productivity. Particularly we use personnel data from a panel of 400 shops from a UK retail chain. The firm uses perfectly flat hourly wage system with no reward for tenure or individual productivity. This system leads to the phenomenon of negative selection, where only employees with lower outside options remain with the firm. We show that negative selection conflicts with human capital so that the relationship between employee turnover and productivity is U-shaped. If negative selection is as important as human capital accumulation in accounting for the U-shape, then devising a wage policy that will reduce negative selection could increase labour productivity considerably. Acknowledgement: The authors want to thank the anonymous firm for kindly providing data on personnel, and the participants at the “Journées de l’ Association Française d’ Economie”, Lyon 2002, for their comments. ♠ Institute for the Study of Social Change, University College Dublin; Centre for the Economics of Education, London School of Economics; and Institute for the Study of Labor (IZA), Bonn. ♣ University of Birmingham ♦ Institute for the Study of Social Change, University College Dublin; and University of Warwick