Management practices, workforce selection, and productivity

Recent research suggests that much of the cross-firm variation in measured productivity is due to differences in use of advanced management practices. Many of these practices - including monitoring, goal setting, and the use of incentives - are mediated through employee decision-making and effort. To the extent that these practices are complementary with workers' skills, better-managed firms will tend to recruit higher-ability workers and adopt pay practices to retain these employees. We use a unique data set that combines detailed survey data on the management practices of German manufacturing establishments with longitudinal earnings records for their employees to study the relationship between productivity, management, worker ability, and pay. As documented by Bloom and Van Reenen (2007) there is a strong partial correlation between management practice scores and firm-level productivity in Germany. In our preferred TFP estimates only a small fraction of this correlation is explained by the higher human capital of the average employee at better-managed firms. A larger share (about 13%) is attributable to the human capital of the highestpaid workers, a group we interpret as representing the managers of the firm. And a similar amount is mediated through the pay premiums offered by better-managed firms. Looking at employee inflows and outflows, we confirm that better-managed firms systematically recruit and retain workers with higher average human capital. Overall, we conclude that workforce selection and positive pay premiums explain just under 30% of the measured impact of management practices on productivity in German manufacturing.