Adverse Selection and Targeting
A major issue in many severance programs is how to avoid adverse selection and rehiring of the best workers. Better targeting and selection of workers help avoid these problems.
In many severance schemes there are concerns about adverse selection: that is, there is concern that the program will lead to the departure of the best workers and thereby result in the loss of critical skills and in the subsequent rehiring of workers who have received public money for severance. This section of the module provides some guidelines for addressing these concerns and making severance more efficient.
When an ex gratia severance payment is offered equally to all workers, it is usually selected by the most skilled and most capable employees. Those employees, who can easily find alternative employment elsewhere in the economy and who believe they have a bright future outside the enterprise, are precisely the people that the restructured enterprise would most want to retain. Overpayment of severance in public enterprises further contributes to adverse selection. In Argentina, for example, early railway retirees were among the most productive employees, whereas many unproductive workers stayed, which led to production problems and shutdowns on various lines. In Pakistan, overly generous severance plans reportedly encouraged the most productive workers to leave.
Enterprise managers are concerned about the potential problem of losing their best people and their knowledge, particularly during periods of transition to new management and new working methods. For PPI investors, however, the transitional challenges of taking over management are more acute because it is vital to avoid disruptions in essential infrastructure services and to keep operations and equipment going until new equipment and systems have been set up.
Adverse selection is a common challenge in work force restructuring.
Mechanisms to better target severance payments are the principal solution to the problem of adverse selection. If there is an across-the-board offer with no targeting or selection, anyone who volunteers for severance is automatically able to receive it, although perhaps on a first-come/first-served basis and perhaps with a cap on the number of workers who can take the offer. This approach is most likely to lead to adverse selection.
Better selection or targeting can be achieved in a number of ways, whether undertaken before PPI by government or after PPI by the new investor. Table 5.6 summarizes the advantages and disadvantages of alternative approaches to selection. (Note, however, that in some cases, the implementing agency or the investor may have little choice of selection tools if these are mandated in a collective bargaining agreement.)
Establishing selection procedures is therefore a critical management task in any labor program. Attention to detail and a commitment to enforce selection are essential. The following sections elaborate on the main tools for better selection and targeting: active management selection, management veto, and selection by cadre.
Active Management Selection
The data sets and tools used for staff audits (see module 3) can help managers in the active selection of staff and cadres for retrenchment. Those tools include:
Personnel records are a first source of data, but human resources departments often lack skilled professionals and adequate recordkeeping.
Selection will be a contentious issue, so a fair process is essential.
The primary problem in management selection is that many worker traits are unobservable. Put simply, it is hard for the designer of a severance program to design selection criteria that distinguish between the productive and the unproductive worker on the basis of written records alone. Reliance on only one test may be unwise, as was found in Guinea and Sri Lanka (see box 5.6).
Guinea: Selection of Water Utility Workers in Conakry
The process of workers to transfer to new water companies was conducted through a series of objective tests (initially managed by the World Bank) that were "supplemented" with recommendations from former managers at the former utility– the DEG. The subjective evaluations raised serious concerns about objectivity (Ménard and Clarke 2000).
Sri Lanka: Worker Selection Processes during Privatization
"It was difficult to screen the high-quality workers from the low-quality workers. Even where exams were held for this purpose, those workers who wanted to leave the firm [through a voluntary departure scheme] performed in the exam very poorly" (Salih 2000, p. 193.)
Using a range of the above tools is wise, and can help assure workers and unions that the process is being carried out in a fair and transparent manner. Selection tools will be most effective where an effective appraisal system is already in place, together with competent and professional human resources management.
Veto by Management
Giving managers the right to reject applications on an individual basis is another option. In practice this is a difficult route for many managers because they have to be prepared to reject applications for voluntary departure from their best workers. The task is made easier if:
Deselection of certain potential [voluntary departure] applicants was done by personally calling those employees and persuading them not to apply since their future in the company was bright (Ray 2001).
Selection by Cadre
Selection can be imposed through eligibility restrictions, which only allow certain groups of workers to participate in a voluntary departure plan. The criteria for selection may be related to age, years of service, cadre, grade, operating unit, or location:
Eligibility is another mechanism for selection and targeting.
As with other selection tools, selection through eligibility criteria requires commitment from government, as was found to be true in Sri Lanka (see box 5.7).
The alternative selection approaches discussed above and outlined in table 5.6 are not mutually exclusive and can be used in a mix. To illustrate, there could be no selection for unskilled cadres who are all surplus workers or for all workers in a regional unit to be closed, but active selection by management of all other cadres.
"Even when tiers of surplus labour were identified before putting VRS into operation, some workers maintained that this was discriminatory and that the option of voluntary retirement should be extended to all workers. However, the main opposition to targeting tiers for retrenchment came from workers who were not targeted. Opposition came from the more skilled grades of workers who felt they could obtain windfall gains through the compensation packages, since they could find alternative jobs without much difficulty. Hence, identifying tiers of redundancy labour for voluntary retirement was eventually dropped and acrossthe- board voluntary retirement was applied. This is why the problem of adverse selection (better workers leaving) was common in Sri Lanka's voluntary retirement process.... Even where workers of an identified tier were subject to VRS, the problem of adverse selection could not be altogether avoided because the better workers within the tier opted to leave" (Salih 2000, p. 193).
| Selection approach | Advantages | Disadvantages |
|---|---|---|
| No targeting (volunteers) |
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| Last-in/ first-out selection |
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| Active management selection | Has a lowered risk of adverse selection |
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| Management veto | Has a lowered risk of adverse selection |
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| Selection by cadre, location, or operating unit | Can deliver a relatively low risk of adverse selection, depending on the structure of the work force and the quality of the staff audit |
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Governments can ask workers to sign a no-return agreement prior to receiving severance, but it can be difficult to enforce restrictions on rehiring within government.
The revolving-door syndrome (where workers are rehired after receiving severance) is indicative of a poorly managed labor program. Many severance schemes therefore set out explicit rules prohibiting rehiring. These are worth having, given the potential political and financial cost of such rehiring. Enforcement is difficult, however, and such restrictions usually can only reduce, not eliminate, the risk of rehiring previously separated workers.
Before they receive their severance benefits employees are usually required to sign a commitment not to return to work in the same enterprise. The design of any restrictions on rehiring will vary among countries and circumstances, but all should address the following aspects:
Enterprise benefits can be complex and time consuming. Detailed manuals may be needed to define exactly how enterprise-level benefits will be treated during severance.
When a PPI investor, Unirail LLC, paid US$31 million to buy a 51 percent stake in Fepasa, a privatized rail line in Chile that the government was putting up for sale, difficulties arose almost immediately. The existing public railway employees had little incentive to stay with the new company because the government was offering them generous pensions to retire immediately. Almost all of them did. Soon the new owners were left with virtually no skilled staff. "This was a really difficult thing for us at all levels," recalls Larry McCaffrey, president of Unirail. "Why they did it, we don't know" (Moline 2000, p. 4).
In 1991 the Chilean Parliament adopted a law offering severance terms to workers who had left EFE, the state railroad. There were two main circumstances:
Neither of these benefits applied to the senior people who were paid more than $1,800 per month and who were free to choose what they wanted.
The principal problem for the PPI investor was that the primary people it wished to hire were the older drivers and electricians with more than 25 years of service because of their experience and their work ethic. Those people, however, did not accept the work because they had a significant financial incentive to stay away. This greatly hurt Fepasa at the time of start-up of operations because the most valuable workers were not available to the concessionaire.
Source: Moline 2000; Unirail LLC, personal communication.
