In this paper we provide theoretical and empirical analyses of an
asymmetric-information model of layoffs in which the current employer is
better informed about its workers’ abilities than prospective employers
are. The key feature of the model is that when firms have discretion with
respect to whom to lay off, the market infers that laid-off workers are of
low ability. Since no such negative inference should be attached to
workers displaced in a plant closing, our model predicts that the post-
displacement wages of otherwise observationally equivalent workers will be
higher for those displaced by plant closings than for those displaced by
layoffs. A simple extension of our model predicts that the post-
displacement unemployment duration of otherwise observationally equivalent
workers will be lower for those displaced by plant closings than for those
displaced by layoffs.
In our empirical work, we use data from the Displaced Workers Supplements
in the January l984 and 1986 Current Population Surveys. For our whole
sample, we find that the evidence (with respect to both re-employment wages
and post-displacement unemployment duration) is consistent with the idea
that laid-off workers are viewed less favorably by the market than are
those losing jobs in plant closings. Furthermore, our findings are much
stronger for workers laid-off from jobs where employers have discretion
over whom to lay off, and much weaker for workers laid-off from jobs where
employers have little or no discretion over whom to lay off.

We develop a dynamic model of learning and wage determination.
Education may convey initial information about ability, but subsequent
performance observations also are informative. Although the role of
schooling in the labor market's inference process declines as performance
observations accumulate, the estimated effect of schooling on the level of
wages is predicted to be independent of labor-market experience. The model
also predicts that time-invariant variables correlated with ability but
unobserved by employers should be increasingly correlated with wages as
experience increases and that wage residuals should be a martingale.
We present evidence from the National Longitudinal Survey of Youth that
is generally consistent with the model's predictions, but a chi-squared
goodness-of-fit test does reject the martingale prediction for wage residuals
even after accounting for classical measurement error. We investigate
alternative specifications and find that a modification of the learning model
that allows for worker ability to evolve as an AR1 process fits the data
quite well.

Measured individual performance often depends on random factors which also
affect the performances of other workers in the same firm, industry, or market. In
these cases, relative performance evaluation (RPE) can provide incentives while
partially insulating workers from the common uncertainty. Basing pay on relative
performance, however, generates incentives to sabotage the measured performance of
co-workers, to collude with co-workers and shirk, and to apply for jobs with inept
co-workers. RPE contracts also are less desirable when the output of co-workers is
expensive to measure or in the presence of production externalities, as in the case of
team production.
The purpose of this paper is to review the benefits and costs of RPE and to test
for the presence of RPE in one occupation where the benefits plausibly exceed the
costs: top-level management. Rewarding chief executive officers (CEOs) based on
performance measured relative to the industry or market creates incentives to take
actions increasing shareholder wealth while insuring executives against the vagaries
of the stock and product markets that are beyond their control. We expect RPE to be
a common feature of implicit CEO compensation and dismissal contracts because the
potential benefit of filtering out common uncertainty is high, the cost of measuring the
performance of other firms is small, and opportunities for sabotage and collusive
shirking are limited.
In contrast to previous research, our empirical evidence strongly supports the
RPE hypothesis-—CEO pay revisions and retention probabilities are positively and
significantly related to firm performance, but are negatively and significantly related
to industry and market performance, ceteris paribus. Our results also suggest that
CEO performance is more likely to be evaluated relative to aggregate market
movements than relative to industry movements.