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Internal labor markets with two types of promotion and two tiers of salary: theory and evidence from China

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  • Jiang, Kun
  • Wang, Susheng

Abstract

This paper shows the optimality of a two-tier linear salary scheme in internal labor markets and identifies conditions under which discretionary promotion is better than rule-based promotion and vice versa. Our main findings are: (1) regardless of whether discretionary promotion or rule-based promotion is used, a two-tier salary scheme is optimal; (2) the salary is contingent on promotion, which is fixed before and linear after promotion; (3) if the difference in human capital among agents is small, discretionary promotion is superior; (4) if the expected replacement cost of human capital is high, discretionary promotion is superior; (5) if the risk of facing/incurring a high replacement cost of human capital is high, discretionary promotion is superior; (6) if the chance of having a high human capital agent is high, rule-based promotion is likely to be superior; and (7) if the productivity improvement from a job promotion is large, rule-based promotion is likely to be superior. We have also found empirical evidence in support of our theory on the two-tier salary scheme.

Suggested Citation

  • Jiang, Kun & Wang, Susheng, 2022. "Internal labor markets with two types of promotion and two tiers of salary: theory and evidence from China," China Economic Review, Elsevier, vol. 72(C).
    • Handle: RePEc:eee:chieco:v:72:y:2022:i:c:s1043951x22000141
    DOI: 10.1016/j.chieco.2022.101756
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    More about this item

    Keywords

    Internal labor market; Linear contract; Two-tier salary; Discretionary promotion; Rule-based promotion;
    All these keywords.

    JEL classification:

    • L2 - Industrial Organization - - Firm Objectives, Organization, and Behavior
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods

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