Carnahan, Seth, Rajshree Agarwal and Benjamin Campbell, Heterogeneity in turnover

20 Pages·2012·0.32 MB·English

Strategic Management Journal
Strat.Mgmt.J.,33:1411–1430(2012)
PublishedonlineEarlyViewinWileyOnlineLibrary(wileyonlinelibrary.com)DOI:10.1002/smj.1991
Received11January2011;Finalrevisionreceived2May2012
HETEROGENEITY IN TURNOVER: THE EFFECT OF
RELATIVE COMPENSATION DISPERSION OF FIRMS
ON THE MOBILITY AND ENTREPRENEURSHIP OF
†
EXTREME PERFORMERS
SETHCARNAHAN,1 RAJSHREEAGARWAL,1*andBENJAMINA.
CAMPBELL2
1RobertH.SmithSchoolofBusiness,UniversityofMaryland,CollegePark,Maryland,
U.S.A.
2FisherCollegeofBusiness,OhioStateUniversity,Columbus,Ohio,U.S.A.
We explore the strategic implications of firm compensation dispersion on the heterogeneous
turnover outcomes of employee mobility and entrepreneurship. We theorize that individuals’
turnover decisions are affected by the interaction of individual performance with the firm’s
compensation dispersion relative to its competitors. We test our theory using linked employer-
employee data from the legal services industry. We find that individuals with extreme high
performance are less likely to leave firms that offer higher compensation dispersion than
competitors, however, if they do leave these employers, they are more likely to create new
ventures. In contrast, employees with extreme low performance are more likely to leave firms
with more compensation dispersion than competitors, and these individuals are less likely to
engageinnewventurecreation.Copyright  2012 John Wiley & Sons, Ltd.
INTRODUCTION stay with the firm instead of joining a compet-
ing organization (Adner and Helfat, 2003; Coff,
Strategyresearchersincreasinglyviewmanagersas 1997). Accordingly, this line of work implicitly
generatorsandappropriatorsofrent(Castaniasand envisions a competition among firms for the ser-
Helfat, 1991, 2001; Coff, 1999). Given the threat vices of employees who differ in their individual
of employee exit, firms often allocate rents with a performance (Gardner, 2005; Harris and Helfat,
focus on permitting high performing employees to 1998).Surprisingly,however,littleresearchexam-
appropriateenoughvaluetoobtainthebestreturns ineshowtheallocationofrentsbythefirm’scom-
to their talents (Campbell et al., 2012b) and thus petitors influences the focal firm’s ability to retain
employees, particularly those employees who gen-
erate the most value. Additionally, entrepreneurial
Keywords: entrepreneurship; turnover; employee mobil-
organizations, key competitors in the market for
ity; compensation dispersion; strategic human capital
*Correspondenceto:RajshreeAgarwal,UniversityofMaryland, strategic human capital (Elfenbein, Hamilton, and
RobertH.SmithSchoolofBusiness,ManagementandOrgani- Zenger,2010;Groysberg,Nanda,andPrats,2009),
zationDepartment,4512VanMunchingHall,CollegePark,MD
have been neglected in most examinations of rent
20742,U.S.A.E-mail:[email protected]
†Allauthorscontributedequally. appropriationandtalentretention.Forexample,the
Copyright  2012 John Wiley & Sons, Ltd.
1412 S. Carnahan, R. Agarwal, and B. A. Campbell
literature on employee entrepreneurship (Agarwal firmswithgreatercompensationdispersionrelative
et al., 2004; Phillips, 2002) is silent on the effect to competitors, but conditional on turnover, they
thatthefirm’srentallocationmayhaveonthelike- are less likely to form new firms. We also provide
lihood of heterogeneous employees creating new some evidence that high and low performers alike
ventures that compete with their parent firms. earn higher compensation after turnover, evidence
In this study, we address these gaps by exam- that employees seek settings that provide them
ining how the firm’s rent allocation—relative to with greater rents, given their performance.
its competitors—influences the turnover decisions In undertaking this study of micro and macro
ofemployeeswhovaryinindividual performance. determinants of employee turnover,1 we integrate
We define turnover broadly as employee exit multiple research streams addressing strategic
from an organization. We then separate turnover human capital. We contribute to the literature on
into mobility and entrepreneurship: mobility when thestrategicmanagementofknowledgebylinking
the employee joins an existing organization and firmcompensationdispersion,animportantmacro-
entrepreneurship when the employee creates or level firm characteristic, to the micro-level mobil-
joins a new venture. These different destinations ity and entrepreneurship behavior of employees.
represent an important heterogeneity in turnover Previousstudieslinkingfirm-levelcontingenciesto
that remains underexplored in the existing litera- entrepreneurial decisions have mainly focused on
ture. In examining rent allocation, we focus on the howfirms’technicalandmarketknowledge(Agar-
firm’s compensation dispersion—the variation in wal et al., 2004; Franco and Filson, 2006) and
monetary rewards provided to the firm’s employ- cultures (Burton, Sørenson, and Beckman, 2002)
ees—which is a crucial organizational attribute determine the likelihood of their employees start-
studiedbyscholarsfromavarietyoffields(Bloom ing new ventures, without giving much attention
andMichel, 2002;GerhartandRynes, 2003;Lam- to how such firm-level characteristics may influ-
bert,Larcker,andWeigelt,1993;PfefferandLang- ence heterogeneous employees differently. We not
ton, 1988, 1993; Shaw and Gupta, 2007; Shaw, only provide the complementary insight that a
Gupta, and Delery, 2002; Trevor and Wazeter, firm’s compensation dispersion affects employee
2006). In examining employee heterogeneity, we entrepreneurship, we also highlight the differen-
focus on extreme performers—employees who tial effect of firm compensation dispersion on
are compensated significantly above or below employees varying in performance. High perform-
their coworkers in the firm with similar observ- ing employees may exit established firms for
able characteristics like education, seniority, age, entrepreneurial ventures to capitalize on underex-
gender, race, and so on. We link individual per- ploited opportunities (Agarwal et al., 2004; Klep-
formance heterogeneity to compensation disper- per and Thompson, 2010), but they may also stay
sion heterogeneity and determine the effect of at firms that allow them to maximize returns to
their interactions on employees’ turnover deci- their ability.
sions regarding mobility to an existing firm or We also contribute to the strategic HR man-
creating an entrepreneurial venture. Given our agementliteratureoncompensationdispersionand
dual focus on individual- and firm-level char- turnover. We highlight that not all turnover events
acteristics, we draw upon work in labor eco- are the same: destination matters in employee
nomics, human resource (HR) management, and mobility, especially if we expand the conceptu-
strategy for hypotheses development. We test our alization of turnover to include entrepreneurship.
hypotheses using unique and comprehensive data Although HR policies rewarding extreme perfor-
drawnfromtheU.S.CensusBureau’sLongitudinal mance help retain high performers, they may be
Employer-Household Database (LEHD). less effective in curtailing entrepreneurship. This
Our study hypothesizes and shows that high difference is important for HR managers because
performingindividualsarelesslikelytoleavefirms employee entrepreneurship may be more harmful
with greater compensation dispersion relative to tofirmperformancethanmereturnover(Campbell
competitors, and, conditional on turnover, high
performers are more likely to form new firms than
join existing ones. For low performing employees, 1Of the many micro-macro divides present in the management
literature (Molloy, Ployhart, and Wright, 2011), we focus on
the opposite is true: we hypothesize and show that
bridging the scholarship gap between individuals and
lowperformingemployeesaremorelikelytoleave organizations.
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
Heterogeneity in Turnover 1413
et al.,2012b;Wezel,Cattani,andPennings,2006). becausetheymayleaveandusetheirtalentstocre-
Also, we underscore the competitive dynamics of ate new ventures that compete directly with their
compensation systems by focusing on a firm’s former employers (Campbell et al., 2012b; Groys-
compensation dispersion relative to its competi- berg et al., 2009). Conversely, low performers
tors, building upon prior work documenting that adversely affect firm profitability (Krackhardt and
individuals look outside of their firm to determine Porter, 1986; Williams and Livingstone, 1994).2
pay satisfaction (e.g., Trevor and Wazeter, 2006).
Finally, we integrate the literatures on manage- Compensation dispersion and value
rial rents and entrepreneurship by systematically appropriation by heterogeneous employees
comparing the decision to form an entrepreneurial
A firm’s compensation dispersion, defined as the
venturewiththeentiresetofoptionsthatindividu-
variationinemployeepaywithinthefirm(Gerhart
alshave,includingstayingatacurrentorganization
and Rynes, 2003), is an important factor in that
or moving to an alternative established firm. By
it has the ability to attract, identify, and retain or
highlighting that founding a new organization is a
discard extreme performers. A firm with greater
rent appropriation mechanism potentially different
compensation dispersion typically provides higher
from mobility to an established firm, our find-
rewardstotheemployeesperceivedtocreatemore
ings underscore the importance of nonpecuniary
value (Bloom and Michel, 2002; Blyler and Coff,
rentstoentrepreneurs.Eventhoughinitialpaymay
2003).Consequently,compensationdispersionhas
be lower in an entrepreneurial venture (Campbell,
an impact on employees’ ability to earn extreme
2012), high performing managers in firms with
rewards and appropriate the rent generated in their
disperse compensation are likely to join new orga-
firm (Castanias and Helfat, 1991; Coff, 1999).
nizations,indicatingthatnonpecuniaryrentsmatter
High compensation dispersion increases the sat-
in the calculus of high ability managers.
isfaction of high performers. Their superior ability
is recognized and rewarded as they either earn
greater within-job-group rewards or more quickly
THEORY AND HYPOTHESES
climb the promotion ladder (Bloom and Michel,
2002; Frank, 1985; Shaw and Gupta, 2007). Low
Heterogeneity in individual performance
performers, on the other hand, appropriate less
Firms are composed of heterogeneous individu- firm value and suffer negative social comparisons
als who achieve differing levels of performance. to the firm’s higher performers (Festinger, 1954).
An important strategic human capital issue relates The situation is different in organizations where
to how firms identify and then retain or discard high and low performers are likely to earn simi-
extremeperformers(Zenger,1992).Assumingrea- lar compensation. This lack of differentiation may
sonably efficient labor markets, we define extreme result when individual contributions to firm per-
high (low) performers as employees who are com- formance are difficult to measure (Alchian and
pensated significantly more (less) than coworkers Demsetz, 1972), and it may engender coopera-
inthesamefirmwhohavesimilarobservablechar- tion (Frank, 1984; Harder, 1992) and limit influ-
acteristics (e.g., education, seniority, age, gender, ence costs (Prendergast, 1999), jealousy (Lazear,
race). We use the terms compensation, rewards, 1989), and costly comparison behavior (Nicker-
and pay interchangeably in this paper. We define son and Zenger, 2008). Lack of compensation dis-
these terms both theoretically and empirically as persion may, however, also result in an implicit
the total taxable income received by an employee cross-subsidization of low performers by high
including wages, salary, and bonuses. performers. Lower compensation dispersion thus
Prior research has linked observable individ-
ual performance differences to unobservable dif- 2Note that prior studies have identified extreme performers by
ferences in innate ability/talent or motivation to definingthereferencegroupattheindustry-(e.g.,Audretschand
Stephan,1996;Zucker,DarbyandBrewer,1998)orfirm-(e.g.,
work (Castanias and Helfat, 1991, 2001; Elfen-
PfefferandDavis-Blake,1992;ShawandGupta,2007;Zenger,
beinet al.,2010;Zenger,1992).Firmstrytoretain 1992) levels of analysis. Given our interest in the interaction
highperformersnotonlybecausetheseindividuals of individual heterogeneity with firm-level differences in com-
pensationdispersion,weadoptedthefirm-levelofanalysisand
drivefirmsuccess(Mindruta,2012;Nyberg,2010;
identified extreme performers by comparing individuals within
Zucker, Darby, and Armstrong, 2002) but also firms.
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
1414 S. Carnahan, R. Agarwal, and B. A. Campbell
may decrease satisfaction for high performers but typically prevail for high performers in firms
increase it for low performers (e.g., Pfeffer and withgreatercompensationdispersion(Gerhartand
Langton, 1993). Rynes, 2003). Even if high performing employees
are dissatisfied with perceived lack of compensa-
Compensation dispersion relative tion dispersion that prevents them from appropri-
to competitors and the turnover of ating rents commensurate with their contributions
extreme performers (Castanias and Helfat, 1991), exiting the firm
will not alleviate this dissatisfaction if competitors
HR management studies examining turnover have
offer even less pay dispersion than their current
studied the relationship between a firm’s compen-
employer.Duetotheirabilitytodeliverincentives
sation dispersion and an employee’s position in
thataresuperiortootherpossibleemploymentdes-
the firm’s performance distribution. These studies
tinations, firms that offer greater pay dispersion
find that the dispersion in the firm’s compensation
than competitors should be better positioned to
is inversely (positively) related to exit by higher
retain their high performing employees. Accord-
(lower)performingemployees,(e.g.,Lazear,2000;
ingly, we hypothesize:
Pfeffer and Davis-Blake, 1992; Shaw and Gupta,
2007),whichisconsistentwithvalueappropriation
Hypothesis 1: The probability that high per-
arguments and with theories of social compari-
formers will exit is lower for firms with higher
son (Festinger, 1954) and equity (Adams, 1963).3
compensation dispersion relative to competing
Missing from these studies, however, is the con-
organizations.
sideration of how the compensation dispersion of
thefirmcompareswiththatofitscompetitors.This
gapisimportantbecauseothercompensationstud- In contrast, low performers are more likely
ies show that employees often determine their pay to exit organizations that offer greater compen-
satisfaction by comparing themselves with refer- sation dispersion relative to competitors because
ent individuals outside of the organization (e.g., they suffer negative social comparisons and gen-
Brown, 2001; Hills, 1980; Law and Wong, 1998; erally perceive pay inequity (Pfeffer and Davis-
TrevorandWazeter,2006).Thus,inasimilarvein, Blake, 1992; Pfeffer and Langton, 1993; Trevor
employeesarelikelytodeterminetheirsatisfaction and Wazeter, 2006). This relationship should par-
with their employer’s pay dispersion by compar- ticularly hold true for low performing employees
ing it to competing organizations’ pay dispersion, at a firm with high compensation dispersion rela-
especially given interfirm competition for talent tive to its competitors because this relative differ-
(Cappelli, 2000; Gardner, 2005) and increasingly ence suggests that other employment destinations
fluid labor markets (Topel and Ward, 1992). In may provide a larger individual return to a lower
short, if competitors offer compensation practices level of individual performance or have less acute
that are more in-line with an employee’s abilities social comparisons. Low performers may thus
andpreferences,theemployeemayexitthecurrent exit firms with higher compensation dispersion to
employer to join these competing firms. join an organization that less tightly links com-
Highperformingindividualsmayprefertowork pensation to relative performance to increase job
inafirmwithgreatercompensationdispersionrel- satisfaction (Miyazaki, 1977; Pfeffer and Davis-
ative to its competitors. Competitors with lower Blake, 1992). Further, firms with greater compen-
compensationdispersionwillbelessabletopoach sationdispersionmaybemorewillingtoterminate
the firm’s high performers by promising more employees who are underperforming relative to
extreme rewards (Zenger, 1992) or better social expectations to make room for better performers’
comparisons (Festinger, 1954), each of which hierarchicalascent(Rosenbaum,1979).Regardless
ofwhetherduetovoluntaryorinvoluntaryexit,we
3The relationship is bolstered further by studies showing that hypothesize:
higherpaydispersionleadstogreaterpaysatisfactionforthose
locatedhigherinthefirm’spaydistributionandlesserpaysat-
isfaction for those located lower in the firm’s pay distribution Hypothesis2:Theprobabilitythatlowperform-
(PfefferandLangton1993;TrevorandWazeter,2006).Connect- ers will exit is greater for firms with higher
ing these results to the turnover literature, Griffeth, Hom, and
compensation dispersion relative to competing
Gaertner(2000)showthatemployeeswithhigherpaysatisfac-
tionarelesslikelytoexit. organizations.
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
Heterogeneity in Turnover 1415
Relative compensation dispersion and competing organizations, a high performer would
entrepreneurship by extreme performers appear to have little reason to move to a different
established firm. More importantly, such a well
We next focus on the question of whether, upon
rewarded high performer will have few options
exit, employees are more likely to engage in
among established competitors to increase appro-
entrepreneurial new venture creation as compared
priation of firm value. An entrepreneurial venture
with joining an established competitor, given both
may be attractive because a firm’s founders are
individual-level performance heterogeneity and
residual claimants who can appropriate maximum
firm-level compensation dispersion heterogeneity.
performance-basedrewards,inamannersimilarto
The literature on employee entrepreneurship
workingentirelyoncommission(Harrison,Virick,
(spin-outs) provides valuable insights regarding
and William, 1996).
the effect of either firm-level characteristics or
Second, to the extent that compensation dis-
individual attributes, but has not addressed the
persion may reflect the extent to which firms
two factors in tandem. In the context of parent
offer rewards for making firm-specific invest-
firm characteristics, scholars have examined how
ments (Becker, 1962; Lazear and Rosen, 1981),
a firm’s performance (Klepper and Sleeper, 2005),
high performers under a dispersed compensation
size (Elfenbein et al., 2010; Sørenson, 2007), and
schememaybediscouragedfrommovingtoestab-
configuration of knowledge assets (Agarwal et al.,
lished competitors because the value of their
2004; Franco and Filson, 2006) affect the likeli- firm-specific human capital investments may sig-
hood of spin-out generation. They generally find nificantlydiminish.Ifahighperformercouldmove
that smaller firms (Boden, 1996; Sørenson, 2007) to an established competitor that offers more com-
and firms with underexploited knowledge (Agar- pensation dispersion and thus the opportunity to
wal et al., 2004) or entrepreneurial cultures (Bur- earn more extreme rewards, sacrificing the value
tonet al.,2002;Gompers,Lerner,andScharfstein, of prior firm-specific human capital investments
2005) produce more spin-outs. However, the role might be worthwhile. However, if a high per-
of differences in firms’ compensation practices former’s current firm offers greater compensation
has been unaddressed. In the context of indi- dispersion than competitors, there will likely be
vidual characteristics, scholars have noted that few established employment destinations provid-
high performing (Groysberg et al., 2009) or high ing enough incentive to sacrifice the firm-specific
earning (Campbell et al., 2012b; Elfenbein et al., component of the high performer’s human capi-
2010)individualsaremorelikelytostartspin-outs tal, even if these rival firms value some portion
than low performers and low earners. Researchers of the high performer’s firm-specific investments
have primarily attributed these differences to the (Campbell, Coff, and Kryscynski, 2012a). In con-
maximization of performance-contingent rewards trast, creating a new venture permits a high per-
for entrepreneurial founders (Braguinsky, Klep- former to replicate parental routines and transfer
per, and Ohyama, 2012) and to the ability of complementary assets (Campbell et al., 2012b;
high performers and high earners to transfer the Wezelet al.,2006),thusallowingthefirm-specific
complementary assets needed to start new ven- component of human capital to retain a greater
tures (Campbell et al., 2012b). An unanswered share of its value than if the employee moved to
question in this research stream is the contingent an established competitor (Ganco, 2012). Conse-
effect of parent firm compensation dispersion on quently, exiting to start a new venture rather than
entrepreneurial decisions among employees who tojoinanotherfirmmayyieldhigherperformance-
differ in performance. contingent rewards (Bragusinksy et al., 2012) for
A firm’s compensation dispersion interacts with a high performer who is already earning extreme
heterogeneity in employee performance to deter- rewards at an existing organization.
mine the likelihood of employee entrepreneurship Additionally, nonpecuniary factors such as
as compared to employee mobility to established autonomy and job satisfaction may influence high
firms. We posit that high performers leaving firms performers’decisionstobeentrepreneurial(Shane,
with more disperse compensation relative to com- Locke, and Collins, 2003). High performers in
petitors will be more likely to form spin-outs. firms that offer disperse compensation relative to
First, if a current firm already provides a high competitors have likely earned many of the pecu-
degree of compensation dispersion compared with niary spoils available from established firms in
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
1416 S. Carnahan, R. Agarwal, and B. A. Campbell
their industry. Consequently, at firms that offer particularly disperse relative to its competitors,
greater compensation dispersion than competitors, non-entrepreneurial employment options that are
high performers may face diminishing marginal more desirable from a social comparison perspec-
pecuniary returns, and thus value nonpecuniary tive are likely to abound. Consequently, joining
factors more highly than high performers at firms a different established firm is likely to be prefer-
with less dispersed compensation (Blanchflower able to creating an entrepreneurial venture for low
and Oswald, 1998; Gompers et al., 2005; Hamil- performers in firms with disperse compensation.
ton, 2000; Puri and Robinson, 2007; Teece, 2003). Thus:
Thus, high performers at firms with disperse com-
pensation have both pecuniary and nonpecuniary Hypothesis4:Conditionalonturnover,theprob-
incentivestoformnewventuresratherthantojoin abilitythatlowperformersformnewventuresis
established firms. lower for firms with higher compensation dis-
persion relative to competing organizations.
Hypothesis3:Conditionalonturnover,theprob-
abilitythathighperformersformnewventuresis
greater for firms with higher compensation dis- METHODS
persion relative to competing organizations.
Empirical setting
Wenextconsiderthelikelihoodofentrepreneur-
shipbylowperformersleavingfirmswithdiffering The U.S. legal services industry is an appropriate
levelsofcompensationdispersion.Asnotedabove, empirical setting for our study for several reasons.
low performers in firms with greater compensa- Itisrepresentativeofprofessionalservices,alarge
tion dispersion relative to competitors may envy and growing sector of the U.S. economy that con-
their colleagues, suffer negative social compar- stituted46.5 percentofthegrossdomesticproduct
isons (Lambert et al., 1993), or be averse to the (GDP)in2007.4 Further,thestructureoftheindus-
high marginal costs of the effort level necessary try facilitates studies of employee turnover and
to earn rewards. However, starting a new venture new firm generation. Professional services indus-
is not likely to be the value-maximizing decision tries are human capital intensive (Sherer, 1994),
for these individuals from either a pecuniary or a and critical complementary assets are more likely
nonpecuniary perspective. to be embodied in mobile people than in physical
On the pecuniary side, while higher compensa- plants or firm-owned intellectual property (Teece,
tion dispersion is intended to extract more effort 2003). Also, employment contracts in legal ser-
from employees (Bloom and Michel, 2002), suc- vices exclude noncompete clauses. Hence, the
cessful entrepreneurship likely requires an even costs/barriers associated with mobility within the
higher level of effort (Zenger, 1994). This is bordersofastate5arerelativelylowforemployees,
particularly true for lower performers who may and new firm creation rates are high. Importantly,
lack the human and social capital (Bragusinksy the heterogeneity in legal services firms’ compen-
and Ohyama, 2009; Sorenson and Stuart, 2001) sation dispersion facilitates the study of structural
needed to attract resources (Shane and Cable, effects on employee turnover, concomitant with
2002) and complementary assets (Agarwal et al., variation in personnel hiring/retention strategies
2012; Campbell et al., 2012b) necessary for entre- (Malos and Campion, 1995; Parkin and Baker,
preneurial success. Thus, the expected pecuniary 2006). In addition, the level of status competition
gains from entrepreneurship may be lower than isveryhigh(Lazega,2001),whichstrengthensthe
thecompensationavailabletolowperformersfrom role of social comparison in employees’ turnover
established firms, including the current employer decisions. One common personnel strategy is the
or alternative options at firms with less dispersed
compensation. On the nonpecuniary side, while
4Statistics on GDP by industry are from the Industry Eco-
forming a new firm may alleviate negative social
nomicAccountsProgramattheBureauofEconomicAnalysis.
comparisons, so too will the less risky option (http://www.bea.gov/industry/xls/GDPbyIndVANAICS1998–
of joining an established firm that offers less 2008.xls).
5Lawyers’credentialsarestate-specificandeasilytransferrable
disperse compensation. If the low performer’s
withinbutnotacrossstateborders.Consequently,mobilitycosts
current employer provides compensation that is arelowwithinstatesandhighbetweenstates.
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
Heterogeneity in Turnover 1417
well-known tournament model, wherein a firm those leaving healthy firms. The final data con-
employs many associates and a few highly paid tained over 1.8M individual-year observations and
partners. The firm pays associates lower salaries, over 87,000 firms.
holds out prospects of future partnership (Malos
and Campion, 1995), and practices ‘up-or-out,’
Estimation strategy
whereby associates who do not make partner gen-
erally leave (Parkin and Baker, 2006). However, We tested our hypotheses for employee turnover
Sherer and Lee (2002) demonstrate that a num- or entrepreneurship in a given year using linear
ber of firms are moving away from the up-or-out probability models. Inclusion of firm-year fixed
model in favor of recruiting partners from both effects absorbed any variation attributable to con-
inside and outside the firm, which may have the stant characteristics within firm years, including
effect of lowering the firm’s compensation disper- unobserved heterogeneity along with average pay,
sion as firms increase associate salaries to com- firm size, area of practice, and so on, and allowed
pensate for poorer partnership prospects (Malos us to focus our hypotheses testing on the differ-
encesamongemployeesworkingforthesamefirm
and Campion, 1995). In summary, the legal ser-
in the same year. We included robust standard
vices industry is an ideal context for our study:
errors (clustered by firm year) to account for het-
it is economically important, has rich variation in
eroskedasticity. Computing constraints restricted
individualperformanceandfirmcompensationdis-
our ability to use a conditional logit model, since
persion, and a high incidence of both types of
confidentiality concerns required all analyses to
employee turnover, namely mobility to existing
be performed on-site at a Census Research Data
firms and entrepreneurship.
Center, using its computing resources. However,
out-of-sample predictions of the linear probabil-
Data ity model were very rare, providing evidence that
the models were performing acceptably. Further,
We analyzed data from the LEHD, which links
estimates from conditional logit specifications on
employer-employee data from state-level unem- a random subsample of our data yielded similar
ployment insurance (UI) records and other data results.
products from the U.S. Census Bureau.6 The data
containquarterlyrecordsofallemployee-employer
Variables
dyads covered by the UI system and include
data collected by many government agencies on Employee turnover
employee characteristics, firm characteristics, and
In the tests of Hypotheses 1 and 2, the dependent
employee earnings. Our data extract included all
variable is employee turnover, coded 1 if an indi-
individuals and firms in legal services in 10 large
vidualhadchangedemploymentsincetheprevious
states between 1990 and 2004. The universality
year and 0 otherwise. For individuals who worked
allowed the construction of employees’ careers
atmultiplefirmsinagivenyear,wefocusedonthe
and firms’ histories over time, and the tracking
dominant employer, defined as the firm at which
of employee mobility and identification of spin-
the employee earned the most during the year.
outevents.Werestrictedoursampletoindividuals
Ourdatadidnotpermitustoidentifyifemploy-
with strong labor market ties (individuals mak-
ees’exitswerevoluntaryorinvoluntary.Weexpect
ing at least $25,000 a year) and to firms large
that, given exceptional performance, on average,
enough to yield a meaningful measure of compen-
high performers would not be involuntarily ter-
sationdispersion(morethanfivepeoplemakingat
minated. We are agnostic as to whether low per-
least $25,000). Additionally, only ‘healthy’ firms
formers were likely to experience voluntary or
that survived for at least two more years after a
involuntarytermination.However,sinceoneofthe
focal year were included. This last restriction was
objectivesofadispersedcompensationdistribution
imposedbecauseemployeeswholeavedyingfirms
is to allow incentives to sort higher performing
aremakingafundamentallydifferentdecisionthan
from lower performing employees with relatively
little managerial intervention (Lazear and Rosen,
1981; Rasmusen and Zenger, 1990), low perform-
6See http://lehd.did.census.gov/led/library/techuserguides/
overviewmasterzeroobs103008.pdf. ersshouldbespurredtoseekdifferentemployment
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
1418 S. Carnahan, R. Agarwal, and B. A. Campbell
options when they do not obtain the performance- each firm’s Gini coefficient by the average Gini
based incentives or promotions necessary to earn coefficient of other firms in the same state. The
rents in a dispersed compensation distribution. measure works particularly well for legal services
Thus, involuntary turnover on the part of low per- since state-specific bar examination requirements
formers should occur more often in firms with typically limit the competition of firms and the
more equitable compensation distributions. As a mobility of lawyers to within state lines (Gilson
result, involuntary turnover in our data would bias and Mnookin, 1985). For reference, it is worth-
resultsawayfromtheconfirmationofourhypothe- while to note that American firms have relatively
ses and provide conservative tests. high compensation dispersion compared to over-
all dispersion in many OECD countries (Lazear
and Shaw, 2008). While the literature has not sys-
Employee exit to spin-out
tematically documented cross-industry variations
In the tests of Hypotheses 3 and 4, we focus on in compensation dispersion, we note that our firm-
only the turnover events and distinguish between level sample mean of the Gini coefficient (0.30)
mobility and entrepreneurship. Accordingly, the is somewhat greater than the average Gini of 0.25
dependent variable is a dummy variable that takes notedbyBloomandMichel’s(2002)studyofman-
the value 1 if the change in an employee’s dom- agers in firms from a variety of industries and
inant employer since the previous year was to a substantially lower than the Gini of 0.60 reported
new firm in the data (employee entrepreneurship), in Bloom’s (1999) study of professional baseball
and takes the value 0 if the change in dominant teams. Other studies measuring firm-level disper-
employer since the previous year was to an exist- sion either use the coefficient of variation (e.g.,
ing firm (employee mobility). We note that this Pfeffer and Davis-Blake, 1992) or an incomplete
measure of exit to spin-out includes not just firm version of the Gini coefficient (e.g., Shaw et al.,
founders but also non-founding employees in the 2002; Shaw and Gupta, 2007).
first year.
High and low performers
Firm’s compensation dispersion relative to
Following prior work documenting a high correla-
competitors (relative Gini coefficient) tion of earnings with individual performance (cf.
Parsons, 1977) we relied on objective compensa-
Following other studies of compensation disper-
tion data to identify high and low performers. In
sionandinlaboreconomics(Bloom,1999;Bloom
keeping with our theoretical framework and prior
andMichel,2002;DonaldsonandWeymark,1980;
research(PfefferandDavis-Blake,1992;Shawand
Shaw et al., 2002) we use the Gini coefficient to
Gupta,2007;Zenger,1992),weidentifiedhighand
measurecompensationdispersion.TheGiniranges
lowperformersusingemployeesintheirownfirms
between 0 (absolute equality) and 1 (absolute
as referents. Elfenbein et al. (2010) accounted for
inequality), measures half the relative mean dif-
individual characteristics (e.g., educational levels)
ference of the pay of any two employees selected
and then defined high and low performers as indi-
atrandomfromafirm’scompensationdistribution,
viduals in the top and bottom deciles of the com-
and is calculated as:
pensation distribution. Extending their framework
(cid:1)n toourcontext,weemployedacompensationresid-
2 iyi n+1 ual approach in identifying extreme performers.
G= i=1 − (1) We developed our measure using two steps. First,
(cid:1)n n we estimated the following ordinary least squares
n y
i compensationequationforeachpersonyearinour
i=1 untrimmed sample:
where y is the salary of the ith ranked individ-
i Log w =β +β X +γZ +δ
ual in a firm and is indexed in nondecreasing it 0 1 it jt STATE
order—that is, i =1 indicates the lowest paid +λ +η +u , (2)
MSA t it
person, and n is the number of people in the
firm. To compute our measure of a firm’s Gini where w is i(cid:1)s total taxable compensation in year
it
coefficient relative to its competitors, we divided t (including salary, bonuses and other reported
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
Heterogeneity in Turnover 1419
taxable income), X is a vector of individual char- confounding variables such as age and tenure that
it
acteristics,includingcontrolvariablesdescribedin may drive both earnings and propensity toward
detail below. Z is a vector of firm-level charac- entrepreneurship.
jt
teristics including an indicator for location in a
metropolitan statistical area (MSA), the interac-
Control variables
tion of the indicator with a continuous measure
of the number of firms in the MSA, and a con- To control for individual characteristics, we in-
tinuous term measuring the number of in-state cluded quadratic term controls for age and firm
competitors. We also included dummy variables tenure. Additionally, we included gender and race
(δ ,λ ,η) capturing the 10 states, the 150 dummy variables, coded 1 for male and white,
STATE MSA t
MSAs, and the 15 years of our sample for each respectively. Since education may have a discon-
observation. The error term is captured by u . tinuous effect on turnover, we included dummies
it
In the second step, we used the distribution of for educational attainment (12 years, between 12
the residual u from the estimated equation to and15 years,16 years,andgreaterthan16 years),
it
identify high and low performers as those indi- with the baseline group consisting of individu-
viduals in the top 10 percent and the bottom 10 als with less than 12 years of education. To con-
percent, respectively, of a focal individual’s cur- trol for individuals with weak employer ties, we
rent firm. We then created two dummy variables. included a dummy for individuals with less than
The first takes a value of 1 if individual i was one year of tenure at their firm. We also included
identified as a high performer at time t. The sec- a dummy that indicated if individuals’ observed
ond takes a value of 1 if i was identified as a tenures were potentially left-censored, an impor-
low performer at time t. Note that this methodol- tant control given that our data began in the mid-
ogy does not result in a few firms containing all dle of the careers of some employees. Firm-level
of the extreme performers—each firm in the data observed and unobserved characteristics are con-
contains both high and low performers. trolled for by a firm-year fixed effect—our empir-
Using the compensation residual approach ical methodology implies that all firm-level vari-
allowed us to identify individuals who are paid ables that are constant for the firm in a particular
more than others in the same firm with the same year(suchasaveragepaylevel,firmsize,lawfirm
age, tenure, education, gender, and race. Condi- specialty,clientmix,etc.)areabsorbedbythefirm-
tioningontheseobservablecharacteristicsallowed year fixed effect.7
us to create very granular comparison groups, Tables 1 and 2 provide descriptive statistics on
and we posit that compensation differences within samplemeansandcorrelationsforallthevariables
the comparison groups are driven by differences included in our study. Notably, approximately
in individual performance. While this approach eight percent of individuals changed employers in
requires the reasonable assumption that firms rec- any given year, and 18 percent of these resulted
ognizevaryinglevelsofperformanceandcompen- in spin-out creation. On average, employees who
sateemployeesaccordingly,defininghighandlow changed employment earned less, were younger,
performers based on their compensation residual and had less tenure than employees who stayed
had three important advantages. First, identifica- with their current employers. Other demographic
tion via comparison with colleagues with similar variables also revealed strong similarities among
observable characteristics was important for our individuals who chose to stay rather than exit.
hypotheses, which highlight the role of firm-level
social comparisons on employee exit. Second,
RESULTS
this method allowed us to identify ‘rising stars,’
which include young employees who are currently
paid a moderate amount absolutely, but are out- Table 3presentsresultsofthetestsofourhypothe-
performing their peer group. Third, Hypotheses ses. The reference (baseline) group of employees
3 and 4 focus on individual performance differ-
ences as impacting moves to entrepreneurial ven- 7Inotherunreportedrobustnessteststotheprimaryanalysis,we
tures or established firms. Using the compensa- included interactions of the extreme performer dummies with
other firm-level characteristics such as total employees, total
tion residual instead of raw compensation to iden-
revenue, and annual firm growth in these two variables. The
tify high and low performers allowed us to avoid resultsremainrobustlysupported.
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj
1420 S. Carnahan, R. Agarwal, and B. A. Campbell
Table 1. Descriptive statistics
Full sample Turnover only sample
Mean SD Mean SD
Turnover? 0.08 0.27 1.00 0.00
Mobility to startup? 0.01 0.12 0.18 0.38
Annual earnings 80373.43 387849.00 62004.18 86642.53
Age 40.90 10.48 38.39 9.52
Education=12 years? 0.13 0.34 0.14 0.35
Education > 12, < 16 0.26 0.44 0.28 0.45
Education=16 years 0.30 0.46 0.30 0.46
Education > 16 years 0.26 0.44 0.25 0.43
Tenure 3.29 2.72 2.41 2.09
Tenure < 1 year? 0.28 0.45 0.40 0.49
Tenure is censored? 0.19 0.40 0.11 0.31
Male? 0.38 0.49 0.33 0.47
High performer? (Top 10% firm wage residual) 0.09 0.29 0.06 0.24
Low performer? (Bottom 10% firm wage residual) 0.07 0.26 0.08 0.28
Relative Gini (Firm Gini/Avg Gini in State) 1.06 0.35 1.07 0.35
Note:n=1,869,633inthefullsampleandn=149,392intheturnoveronlysample.
is in the middle of the compensation residual dis- firms with Gini coefficients that are high relative
tributionatthefirmlevel(employeesinthe20–90 to competitors. A one standard deviation increase
percent range). Model 1 is the estimate of the (decrease)intherelativeGinicoefficientdecreases
impact of the interaction between employee per- (increases) the probability that high performers
formance and firm compensation dispersion on will exit their current employer by 16 percent.
employee turnover (Hypotheses 1 and 2). The Hypothesis2,incontrast,positsthatthelikelihood
relationship of the control variables to the mobil- of turnover increases for low performers who are
ity of employees observed is broadly consistent employed at firms with higher relative pay dis-
with extant turnover literature (Griffeth, Hom, and persion. The coefficients for the interaction effects
Gaertner,2000):olderandmaleemployeesareless support this relationship too: low performers are
likely to leave, and employee tenure at the firm more likely to exit when working for firms with
has a U-shaped relationship with turnover. Educa- high values of the relative Gini coefficient (i.e.,
tion has a discontinuous effect on turnover, with the interaction term is positive and significant).
onlyemployeespossessingsomecollegeeducation A one standard deviation increase (decrease) in
being more likely to be mobile relative to the ref- an employer’s relative Gini coefficient from mean
erencegroup.NotethatthemaineffectoftheGini levels leads to a 5.5 percent increase (decrease) in
coefficient of firm pay dispersion is not reported theprobabilitythatalowperformerexitsacurrent
in the tables because it was calculated at the firm- employer.
year level and, as a result, was absorbed by the Model 2 of Table 3, provides the results of the
firm-year fixed effects in the models. Given that tests for Hypotheses 3 and 4, which examine the
our hypothesized relationships focus on the inter- likelihood,conditionalonturnover,ofanemployee
actions of the Gini coefficient with high and low founding or joining a new firm rather than becom-
performance, hypotheses testing focused on these ing employed at a different existing firm. Among
interaction terms. the control variables, age, education, and being
Hypothesis 1 posits that the likelihood of turn- male are positively related to entrepreneurship.
over decreases for high performers who are em- Firm tenure has an inverted U-shaped relation-
ployed at firms with higher compensation dis- ship with it. As for our main variables of interest,
persion relative to competitors. The negative and in Hypothesis 3, we predict that high perform-
significant interaction with the relative Gini coef- ers are more likely to be entrepreneurs if they
ficient supports this hypothesis: high performers are employed in firms with high compensation
are less likely to exit if they are employed at dispersion relative to competitors. The interaction
Copyright2012JohnWiley&Sons,Ltd. Strat.Mgmt.J.,33:1411–1430(2012)
DOI:10.1002/smj