Retention of Capable New Employees under Uncertainty: Impact of Strategic Interactions

Abstract

We study a game involving a firm and a newly hired employee whose
capability is initially unknown to both parties. Both players observe
the performance of the employee and update their common posterior
beliefs about the employee's capability. The learning process presents
each party with an option: the firm can terminate an incapable employee,
and a capable employee can leave the firm for greater financial remuneration
elsewhere. To understand the impact of this noncooperative interaction,
we examine the Markov perfect equilibrium termination strategies
and payoffs that unfold. We find that in the region of sufficiently
high learning rates, reducing the rate of learning can increase the
equilibrium payoff for both parties. Slower learning prolongs the
employment because more performance outcomes must be observed for
assessing the employee's capability. In the region of sufficiently slow learning rates, reducing
the rate of learning can benefit the firm if the employee is deemed capable
but hurt the firm otherwise. Our result identifies a nonfinancial
way for firms to improve retention of capable new employees.

Keywords: Decision analysis, inference, Games/group decisions, stochastic, Probability, diffusion, Entrepreneurial operations, employee retention, real options game, Bayesian sequential decision