{"id":681832,"date":"2025-11-18T08:25:42","date_gmt":"2025-11-18T13:25:42","guid":{"rendered":"https:\/\/www.rochester.edu\/newscenter\/?p=681832"},"modified":"2025-11-18T08:25:42","modified_gmt":"2025-11-18T13:25:42","slug":"employee-turnover-why-top-firms-churn-good-workers-681832","status":"publish","type":"post","link":"https:\/\/www.rochester.edu\/newscenter\/employee-turnover-why-top-firms-churn-good-workers-681832\/","title":{"rendered":"Why top firms paradoxically fire good workers"},"content":{"rendered":"

Elite firms\u2019 notorious \u2018revolving door\u2019 culture isn\u2019t arbitrary but a rational way to signal talent and boost profits, a new study finds.<\/h2>\n

Why do the world\u2019s most prestigious firms\u2014such as McKinsey, Goldman Sachs and other elite consulting giants, investment banks, and law practices\u2014hire the brightest talents, train them intensively, and then, after a few years, send many of them packing? A recent study<\/a> in the\u00a0American Economic Review<\/em>\u00a0concludes that so-called adverse selection is not a flaw but rather a sign that the system is working precisely as intended.<\/p>\n

Two financial economists, from the Ä¢¹½´«Ã½<\/a> and the University of Wisconsin\u2013Madison respectively, created a model that explains how reputation, information, and retention interact in professions where skill is essential and performance is both visible and attributable to a specific person, particularly in fields such as law, consulting, fund asset management, auditing, and architecture. They argue that much of the professional services world operates through \u201cintermediaries\u201d\u2014firms that both hire employees (also referred to as \u201cagents\u201d or \u201cmanagers\u201d) and market their expertise to clients\u2014because clients can\u2019t themselves easily judge a worker\u2019s ability from the outset.<\/p>\n

\u201cIdentifying skilled professionals is critical yet presents a major challenge for clients,\u201d the researchers write. \u201cSome of the firm\u2019s employees are high-quality managers,\u201d says coauthor Ron Kaniel<\/a>, the Jay S. and Jeanne P. Benet Professor of Finance at the University\u2019s Simon Business School<\/a>, \u201cbut the firm is paying them less than their actual quality, because initially the employees don\u2019t have a credible way of convincing the outside world that they are high-quality.\u201d<\/p>\n

\u2018Churning\u2019 to boost reputation<\/strong><\/h3>\n

At the start of an employee\u2019s career, the firm has an advantage, Kaniel and his coauthor Dmitry Orlov contend, because the firm (\u201cthe mediator\u201d) can assess an employee\u2019s talent more accurately than outside clients can. During what the authors call \u201cquiet periods,\u201d the firm keeps those who perform adequately and pays them standard wages.<\/p>\n

Workers accept being underpaid temporarily because remaining at a top firm signals their elite status to the market.<\/div>\n

Over time, however, an employee\u2019s public performance\u2014measured by successful cases, profitable investments, or well-executed projects\u2014reduces the firm\u2019s informational advantage. As the informational gap shrinks, the firm needs to pay some employees more because clients are now able to observe an employee\u2019s good performance and hence update their beliefs about the employee\u2019s skills.<\/p>\n

\u201cAt some point, the informational advantage becomes fairly small,\u201d says Kaniel, \u201cand the firm says, \u2018Well, I will basically start to churn. I will let go of some employees, and by doing that, I can actually extract more from the remaining ones.\u2019\u201d<\/p>\n

Ironically, to the client these churned\u2014or strategically fired\u2014employees look just as good as the ones whom the firm kept. Churning happens not because these employees have failed but because they may be just somewhat lower-skilled than their peers. Subsequently, churning heightens both the reputation of the firm and of the employees who remain.<\/p>\n

A paradoxical equilibrium<\/strong><\/h3>\n

Somewhat counterintuitively, the researchers show that churning can benefit both sides. Workers who stay on with an elite firm accept lower pay in the short run as the tradeoff for building a stronger reputation for themselves. When these workers eventually leave the elite firms, they can command higher fees directly from clients.<\/p>\n

What looks like a ruthless system of constant employee turnover is, in fact, a finely tuned mechanism that helps the market discover and reward true talent.<\/div>\n

As a result of the churning, the informational gap between firm and client keeps shrinking because the client catches up to what the firm knows about its workers and which ones it values most. At first glance, the duo argues, the firm\u2019s reduced informational advantage should now cause a further drop in profits. But here comes the strategic twist: The firm starts to underpay those better workers who kept their jobs, akin to making them pay for being \u201cchosen.\u201d Consequently, profits do not decline and may even increase.<\/p>\n

\u201cFirms now essentially can threaten the remaining employees: \u2018Look, I can let you go, and everybody\u2019s going to think that you\u2019re the worst in the pool. If you want me not to let you go, you need to accept below market wages,\u2019\u201d says Kaniel.<\/p>\n

The result is a paradoxical but stable equilibrium. Workers accept being underpaid temporarily because remaining at a top firm serves as a signal to the market about their elite status. It also helps explain why prestigious employers can attract ambitious newcomers despite grueling hours and relatively modest starting pay.<\/p>\n

Meanwhile, those who are let go aren\u2019t failures\u2014rather, their exit is part of a system that signals who\u2019s truly top-tier, the researchers argue. In fact, fired workers often find success on their own because potential clients interpret a person\u2019s prior affiliation with a top firm as proof of the worker\u2019s strong ability and qualifications.<\/p>\n

In short, the \u201cup-or-out\u201d path of professional life may not just be a cultural phenomenon among top professional service firms but also an efficient response to how reputation is maintained and information flows. What looks like a ruthless system of constant turnover, the researchers argue, is in reality a finely tuned mechanism that helps the market discover and reward true talent.<\/p>\n","protected":false},"excerpt":{"rendered":"

Elite firms\u2019 notorious \u2018revolving door\u2019 culture isn\u2019t arbitrary but rather a way to signal talent and boost profits, a new study finds.<\/p>\n","protected":false},"author":942,"featured_media":681912,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[456],"tags":[18572,42442,10406],"class_list":["post-681832","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-society-culture","tag-research-finding","tag-ron-kaniel","tag-simon-business-school"],"acf":[],"yoast_head":"\nWhy top firms paradoxically fire good workers<\/title>\n<meta name=\"description\" content=\"Elite firms\u2019 culture of employee turnover isn\u2019t arbitrary but a rational way to signal talent and boost profits, a new study finds.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" 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