Why External Hires Get Paid More, and Perform Worse, than Internal Staff

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Bidwell offers this career advice: “If you like where you are, stay there. Or at least understand how hard it can be to take your skills with you. You think you can go to another job and perform well, but it takes a long time to build up to the same effectiveness that you had in your previous organization. You need to be aware that often your skills are much less portable than you think they are.” Bidwell is clearly a fan of internal mobility. “While the pay may be less, your performance is better, and there is more security.”

‘Let’s Make a Deal’

For his research, Bidwell analyzed personnel data from a U.S. investment banking division from 2003 to 2009. In that study, he documented twice as many internal promotions as external hires. Investment banking, Bidwell writes, represents “an interesting context in which to study the effects of internal versus external mobility [because] organizational performance often depends on the skills of the workforce, [thereby] increasing the importance of personnel decisions.” In addition, workers in banking are “notoriously mobile, making this a context in which organizations regularly engage in external hiring at all levels.”

One important feature of investment banking jobs is that promotions tend to involve some measure of continuity with the prior job. Promotions often involve getting a higher title, such as vice president or director, while continuing to do similar work. In fact, as Bidwell notes, promotions in many organizations do not instantly lead into a very different job. Instead, responsibilities increase gradually, being recognized over time by a promotion. When considering their future staffing needs, though, organizations still must think about how they will acquire the workers capable of operating at the higher levels: Will it be by hiring or promotion?

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Bidwell found similar patterns for different kinds of jobs and within different organizations. He analyzed separately the investment professionals (traders, salespeople, research analysts and investment bankers) and the support staff at the research site. His findings about pay and performance were consistent across those groups. He also looked at another investment bank and a publishing company, and found the same results of “paying more for external hires while giving them lower performance ratings.”

He concludes, however, that the nature of the promotion mattered. Unlike other promoted workers, those who were simultaneously promoted and transferred to another group did not perform any better than external hires. Bidwell speculates that “the skills that are important to our jobs may be very specific to the positions that we are in. Even large changes in the nature of jobs within the organization were associated with performance declines.”

Yet overall, Bidwell says, external hiring has grown much more frequent since the early 1980s, especially for experienced high level positions and especially in larger organizations. “It used to be that smaller organizations always did a lot of outside hiring while big ones focused more on internal mobility. But now the pendulum has shifted toward external hiring and away from internal mobility for large organizations as well.

“Companies should understand that it can often be harder than it seems to bring in people who look good on paper,” says Bidwell. “In addition, there is a suspicion that ‘the grass is always greener’ attitude plays a role in some companies’ desire to hire from the outside. Managers see a great CV and get excited about playing ‘Let’s Make a Deal,’ even when it’s hard to know what weaknesses the external hires bring with them.”

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On the other hand, “to promote more people internally also means that companies need to have a long-term perspective and know how big a pipeline of people will be needed in the future,” notes Bidwell. It also requires managers to ensure that internal people are aware of the opportunities open to them. “Finally, there are clearly some costs to internal mobility — for example, the cost of training people in-house versus piggybacking on someone else’s training.”

Another variable in the mobility equation, he adds, concerns non-compete clauses which tend to complicate the movement of employees between competing firms. “Although these have not always been so salient in investment banking, non-compete agreements have become increasingly important in many states and many jobs, particularly in areas like technology where employers can plausibly claim that employees will take critical competitive knowledge with them.”

‘Involuntary Exits’

In his paper, Bidwell argues that the differences between internal and external mobility all ultimately stem from two factors: the skills workers bring from their prior jobs, and the amount of information that firms and workers have about each other.

He comments on the significant amount of new knowledge that external hires are required to learn, even in those jobs that demand “high levels of general skills, such as securities research, scientific research and surgery…. Although such work depends on individual workers’ skills and knowledge, it can also require intense coordination with others in the organization.” Because internal movers have longer experience within the firm, “they are likely to have already acquired important firm-specific skills that new hires will lack,” Bidwell writes.

In terms of the process that takes place when firms and external employees are eyeing each other for a possible matchup, Bidwell writes that the task can be difficult because each side often has “highly incomplete information about each other. Firms struggle to evaluate the true qualities of applications, and workers struggle to know which of the jobs available will best suit their preferences and abilities.” But, as Bidwell notes, companies obviously have more information about internal job candidates, including how well they have performed in prior roles and how well they fit in with the current organization.

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Bidwell suggests that his paper “provides unique evidence on the value to firms of internal labor market structures. Results show that internal mobility allows the firm to staff higher-level jobs with workers who have better performance but are paid less.” By detailing the strong advantage of internal mobility over external hires, he adds, “these findings help to explain the continued resilience of internal labor markets in the face of pressures for worker

Republished with permission from Knowledge@Wharton, the online research and business analysis journal of the Wharton School of the University of Pennsylvania.

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