Skill Profiles, Observability and Firm Hierarchies: A Theory of Promotion and Compensation

Within a hierarchical firm structure, the paper details how the composition of a worker's skills and the (non) observability of a worker's ability affect wage and promotion paths. Promotion takes place over time and is not efficient, as employers seek to exploit their inside information about a worker's ability. Employers are led to promote educated employees before their equally or more able, but uneducated, counterparts. The relationship between pay and performance at a given job grade is ambiguous. Explanations for fast track promotion plans, the lack of demotion for poor managers, and other empirical regularities are provided.