Internal and External Hiring of Employees- Costs and Benefits

A firm that has an open position to fill can typically choose from various candidates. In particular, it can decide to promote some employee from inside the firm or, alternatively, hire a candidate from outside. Empirical observations show that both, internal and external hiring, takes place on various levels of hierarchy.
In this project, we investigate what drives the choice of either external or internal hiring. Moreover, we analyze the consequences of that choice for incentive contracting.
To do so, we assume that internal candidates are better informed about the firm itself, the position to fill and the possible achievements from filling the position as opposed external candidates. From that perspective, the choice for an internal versus an external candidate boils down to the question of whether to hire someone with more or less private information trading off more information and larger information asymmetry against less information combined with less information asymmetry. Formally, we compare an agency problem with moral hazard and adverse selection to a pure moral hazard problem.
Early results show that it depends critically on the differences in types whether hiring an internal or an external candidate results in higher expected payoffs for the firm. The same is true for the optimal intensity of incentives provided.