The contribution of the wage structure to early retirement behaviour

Wolfgang Frimmel, Rudolf Winter-Ebmer 28 October 2015

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In most European countries, labour force participation is low amongst the elderly, as is average retirement age, leading to squeezes on the social security system. Typically, the economic literature treats retirement decisions as purely driven by labour supply and, thus, most scholars have focused on individual retirement incentives. There is a large literature on the influence of health (Currie and Madrian 1999), individual productivity (Burtless 2013), working conditions (Schnalzenberger et al 2014), the generosity of social security systems in terms of pensions (Van Soest and Vonkova 2013) and retirement age regulations (Mastrobuoni 2009 or Staubli and Zweimüller 2013).

In spite of this research concentration on (voluntary) labour supply effects, surveys often reveal that a large proportion of workers state that they did not retire so early voluntarily; rather, some external forces might have been important as well (e.g., see Dorn and Sousa-Poza 2010, or Marmot et al 2004 for England).  One such external factor in early retirement behaviour could be firms.

Several studies have looked at the relevance of firm policies with respect to the retirement behaviour of its workers. Bartel and Sicherman (1993), Bello and Galasso (2014) and Bellmann and Janik (2010) explore the role of technology and trade shocks on retirement. Hakola and Uusitalo (2005) analyse the introduction of an experience-rating of early retirement benefits in Finland and find a significant reduction of early job exits of older workers. This implies that a firm has an impact on retirements, as workers need to be laid off before obtaining early retirement benefits at all.

Wage structure

From an economic policy point of view, it is particularly interesting whether a firm’s wage structure can contribute to the early retirement behaviour of their workers.  In principle, firms are indifferent with regard to the retirement age of their workers if age-wage profiles correspond to age-productivity profiles. Otherwise, firm incentives to lay off older workers arise, whenever age-wage profiles exceed age-productivity profiles (see Figure 1). These theoretical considerations are based on an implicit contract model (Lazear 1979). In order to discourage employee shirking and malfeasance, a firm and its workers may adhere to an implicit contract, whereby workers' wages are below their marginal product at the beginning and higher at the end of their career with the firm. While such a contract eliminates the shirking incentives of the workers, it opens up moral hazard problems from the side of the firm – a steep seniority wage schedule, on the one hand, stimulates workers to stay longer with the firm to profit from these ‘rents’; on the other hand, firms may want to terminate the contract prematurely to reduce wage costs.

Figure 1

It turns out that the steepness of a firm's seniority-wage profile relative to productivity development is key in differentiating between firms' and workers' decisions for early retirement. Ceteris paribus, a steeper profile will increase the incentive for early retirement for the firm, but at the same time, individual retirement incentives will decrease due to higher expected social security benefits implied by higher wages close to retirement. A firm effect on individual retirement can only be separated from the individual retirement decision if individual incentives are addressed properly within the empirical framework.

Austrian firms and workers

In a recent paper, we look at firm seniority wage structures in Austria to explore the role of labour demand in retirement outcomes (Frimmel et al 2015). We use high-quality administrative data for the universe of Austrian workers and firms over more than a decade to observe retirement patterns of firms, and calculate seniority wage profiles for each firm. Figure 2 shows the retirement ages of workers in the 20 largest firms in mechanical engineering. While these firms may offer rather similar working conditions in terms of health demands, mean retirement dates in these firms differ widely. This points towards a role for firms in retirement decisions as well.

Figure 2. Retirement ages of workers in the 20 largest firms in mechanical engineering

Because such a seniority wage schedule may be set on purpose (e.g., for incentive reasons), we use deviations from detailed industry averages and predict firm seniority schedules by labour market shocks a decade ago in an instrumental variables strategy.

Results show that, indeed, steep age-wage profiles in a firm reduce the retirement age of its workers – a one standard deviation increase in the steepness of the wage gradient in a firm leads to an earlier job exit of approximately 6 months for blue-collar and 5 months for white-collar workers. Moreover, the prevalence of golden handshakes increases as well – these workers do not enter formal retirement any earlier, but rather bridge the gap until formal retirement with the receipt of unemployment benefits.

One interpretation of these results is that firms play an active role in the determination of their workers' retirement age. Given individual retirement incentives - represented by detailed social security wealth calculations - a steeper wage gradient will stimulate firms to get rid of elderly workers prematurely; although, on the other hand, the workers would have an incentive to hold on to these good jobs even longer.

Concluding remarks

Recognising and quantifying an active role of firms in the retirement processes is a major step in discussions about early retirement problems and potential remedies.  From a policy perspective, these results suggest that decreasing firm incentives by reducing seniority wage profiles – that is, flattening the wage profiles at higher ages – can increase employment at older ages. Since early labour market exit is associated with a higher cost to social security systems (via prolonged receipts of unemployment benefits or pension payments), firms could also be obliged to bear parts of these costs directly – for example, via some sort of experience rating.

The construction of deferred compensation schedules via steep age-wage profiles (Lazear 1979) typically requires some form of mandatory retirement age. Increasing the regular retirement age – as is discussed in many countries – would, thus, also be costly for firms – given a seniority wage contract, a later retirement age would require firms to keep older and expensive workers on the payroll for longer.  While in the long run new contracts will take this longer working life into account, in the short run incentives for firms to renege on these contracts may increase.

References

Bartel, A P and N Sicherman (1993) “Technological change and retirement decisions of older workers”, Journal of Labor Economics, 11(1): 162–183.

Bellmann, L and F Janik (2010) “Betriebe und Frühverrentung: Angebote, die man nicht ablehnt”, Zeitschrift für Arbeitsmarktforschung, 42(4): 311–324.

Bello, P and V Galasso (2014) “Old before their time: The role of employers in retirement decisions”, mimeo, Bocconi University.

Burtless, G (2013) “The impact of population aging and delayed retirement on workforce productivity”, Tech. rep., Center for Retirement Research at Boston College.

Currie, J and B C Madrian (1999) “Health, health insurance and the labour market”, Handbook of labour economics, 3, 3309–3416.

Dorn, D and A Sousa-Poza (2010) “’Voluntary’ and ‘involuntary’ early retirement: An international analysis”, Applied Economics, 42(4): 427–438.

Frimmel, W, T Horvath, M Schnalzenberger  and R Winter-Ebmer (2015) “Seniority wages and the role of firms in retirement decisions”, Working paper, University of Linz.

Hakola, T and R Uusitalo (2005) “Not so voluntary retirement decisions? Evidence from a pension reform”, Journal of Public Economics, 89(11): 2121–2136.

Lazear, E P (1979) “Why is there mandatory retirement?” The Journal of Political Economy, pp. 1261–1284.

Marmot, M, J Banks, R Blundell, C Lessof and J Nazroo (2004) “Health, wealth and lifestyles of the older population in England: The 2002 English longitudinal study of ageing”, London: Institute for Fiscal Studies.

Mastrobuoni, G (2009) “Labour supply effects of the recent social security benefit cuts: Empirical estimates using cohort discontinuities”, Journal of Public Economics, 93(11): 1224–1233.

Schnalzenberger, M, N Schneeweis, R Winter-Ebmer and M Zweimüller (2014) “Job quality and employment of older people in Europe”, Labour, 28(2): 141-162.

Staubli, S and J Zweimüller (2013) “Does raising the early retirement age increase employment of older workers?” Journal of Public Economics, 108(1): 17–32.

Van Soest, A and H Vonkova (2013) “How sensitive are retirement decisions to financial incentives? A stated preference analysis”, Journal of Applied Econometrics.

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Tags:  labour; labour markets; EU; Europe; retirement; aging; productivity; seniority; wages; deferred compensation; implicit contract; early retirement; social security; Austria; administrative data;

Assistant Professor, Johannes Kepler University Linz

Professor at Labour Economics at the University of Linz and at the Institute for Advanced Studies, Vienna. CEPR Research Fellow

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