Why External Hires Get Paid More, and Perform Worse, than Internal Staff

Published: March 28, 2012 in Knowledge@Wharton

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Share on facebook Share on twitter Share on email More Sharing Services Here is some research sure to rankle every employee who has applied for an internal promotion and been passed over in favor of someone brought in from the outside. According to Wharton management professor Matthew Bidwell, "external hires" get significantly lower performance evaluations for their first two years on the job than do internal workers who are promoted into similar jobs. They also have higher exit rates, and they are paid "substantially more." About 18% to 20% more. On the plus side for these external hires, if they stay beyond two years, they get promoted faster than do those who are promoted internally. "Most jobs are entered into through a variety of different routes, sometimes by being hired from the outside and sometimes by moving up from inside the firm," says Bidwell. "I was curious as to what the effect of these different routes would be" on an individual's job performance. His research is presented in a paper titled, "Paying More to Get Less: The Effects of External Hiring versus Internal Mobility." The issue has significance for organizations, Bidwell says, as they think about where they source their employees, especially higher-level ones. Do they "grow their own" or do they go out into the job market and hire outsiders? "My research documents some quite substantial costs to external hires and some substantial benefits to internal mobility," he notes. Getting Up to Speed The context for Bidwell's research lies in the increased mobility of workers over the past three decades as companies have turned away from offering lifetime employment in favor of relying on the external labor market to find experienced workers at all levels of the organization.

By comparing internal mobility and external hiring processes -- looking specifically at performance and pay -- Bidwell's research can help employees learn more about "the consequences of their career decisions," including the tradeoffs that characterize internal and external mobility, Bidwell writes in his paper. Some of those tradeoffs are easily identified. In noting that external hires need about two years "to get up to speed" in their new jobs, Bidwell suggests it is because outsiders need that amount of time to learn how to be effective in their new organization -- specifically, how to build relationships. Meanwhile, the risk of failure is substantial. Although external hires are paid quite a bit more than employees promoted into similar jobs, "this is not a free lunch for the external hires," he says. "There is a much greater risk of being let go during those first few years, mainly because they may not develop the necessary skills and thus will not perform as well as expected. Then, too, they might decide to leave voluntarily." While doing his research, Bidwell noted one particular difference between the external hires and those already in the company who are being promoted. "People hired into the job from the outside often have more education and experience [than internal candidates], which is probably some of the reason they are being paid more," he says. "When you know less about the person you are hiring, you tend to be more rigorous about the things you can see" -- such as education and experience levels listed on a person's CV, or what Bidwell calls "externally observable attributes." And yet "education and experience are reasonably weak signals of how good somebody will be on the job, he notes. Those tradeoffs might help explain why external hires earn so much more than internal employees promoted into the same jobs. If these hires have better resumes and are perceived as able to get a job more easily outside the company, then they can demand higher pay than internal people. Hires may also want higher pay to reflect the unfamiliar environment that they face on coming into a new position. Hiring managers confirm that they typically pay 10% or 20% more to pull people out of positions "where they already have some security and where people know them and know they are doing a good job," Bidwell says. He acknowledges that his research may frustrate an organization's in-house workforce. "It is sadly the case that being more marketable, as external candidates are, is always going to be valuable and will generally lead to higher compensation. So the question is, should internal people threaten to quit to raise their pay?" It's well known in academia, for example, that the only way to get a significant pay raise is to nail down an outside offer, Bidwell notes. "But in some organizations, that's an easy way to get fired. People will take it as a signal that you are disloyal." Bidwell offers this career advice: "If you like where you are, stay there. Or at least understand how hard it can be to take your skills with you. You think you can go to another job and perform well, but it takes a long time to build up to the same effectiveness that you had in your previous organization. You need to be aware that often your skills are much less portable than you think they are." Bidwell is clearly a fan of internal mobility. "While the pay may be less, your performance is better, and there is more security." 'Let's Make a Deal'

For his research, Bidwell analyzed personnel data from a U.S. investment banking division from 2003 to 2009. In that study, he documented twice as many internal promotions as external hires. Investment banking, Bidwell writes, represents "an interesting context in which to study the effects of internal versus external mobility [because] organizational performance often depends on the skills of the workforce, [thereby] increasing the importance of personnel decisions." In addition, workers in banking are "notoriously mobile, making this a context in which organizations regularly engage in external hiring at all levels." One important feature of investment banking jobs is that promotions tend to involve some measure of continuity with the prior job. Promotions often involve getting a higher title, such as vice president or director, while continuing to do similar work. In fact, as Bidwell notes, promotions in many organizations do not instantly lead into a very different job. Instead, responsibilities increase gradually, being recognized over time by a promotion. When considering their future staffing needs, though, organizations still must think about how they will acquire the workers capable of operating at the higher levels: Will it be by hiring or promotion? Bidwell found similar patterns for different kinds of jobs and within different organizations. He analyzed separately the investment professionals (traders, salespeople, research analysts and investment bankers) and the support staff at the research site. His findings about pay and performance were consistent across those groups. He also looked at another investment bank and a publishing company, and found the same results of "paying more for external hires while giving them lower performance ratings." He concludes, however, that the nature of the promotion mattered. Unlike other promoted workers, those who were simultaneously promoted and transferred to another group did not perform any better than external hires. Bidwell speculates that "the skills that are important to our jobs may be very specific to the positions that we are in. Even large changes in the nature of jobs within the organization were associated with performance declines." Yet overall, Bidwell says, external hiring has grown much more frequent since the early 1980s, especially for experienced high level positions and especially in larger organizations. "It used to be that smaller organizations always did a lot of outside hiring while big ones focused more on internal mobility. But now the pendulum has shifted toward external hiring and away from internal mobility for large organizations as well. "Companies should understand that it can often be harder than it seems to bring in people who look good on paper," says Bidwell. "In addition, there is a suspicion that 'the grass is always greener' attitude plays a role in some companies' desire to hire from the outside. Managers see a great CV and get excited about playing 'Let's Make a Deal,' even when it's hard to know what weaknesses the external hires bring with them." On the other hand, "to promote more people internally also means that companies need to have a long-term perspective and know how big a pipeline of people will be needed in the future," notes Bidwell. It also requires managers to ensure that internal people are aware of the opportunities open to them. "Finally, there are clearly some costs to internal mobility -- for example, the cost of training people in-house versus piggybacking on someone else's training."

Another variable in the mobility equation, he adds, concerns non-compete clauses which tend to complicate the movement of employees between competing firms. "Although these have not always been so salient in investment banking, non-compete agreements have become increasingly important in many states and many jobs, particularly in areas like technology where employers can plausibly claim that employees will take critical competitive knowledge with them." 'Involuntary Exits' In his paper, Bidwell argues that the differences between internal and external mobility all ultimately stem from two factors: the skills workers bring from their prior jobs, and the amount of information that firms and workers have about each other. He comments on the significant amount of new knowledge that external hires are required to learn, even in those jobs that demand "high levels of general skills, such as securities research, scientific research and surgery.... Although such work depends on individual workers' skills and knowledge, it can also require intense coordination with others in the organization." Because internal movers have longer experience within the firm, "they are likely to have already acquired important firm-specific skills that new hires will lack," Bidwell writes. In terms of the process that takes place when firms and external employees are eyeing each other for a possible matchup, Bidwell writes that the task can be difficult because each side often has "highly incomplete information about each other. Firms struggle to evaluate the true qualities of applications, and workers struggle to know which of the jobs available will best suit their preferences and abilities." But, as Bidwell notes, companies obviously have more information about internal job candidates, including how well they have performed in prior roles and how well they fit in with the current organization. Bidwell suggests that his paper "provides unique evidence on the value to firms of internal labor market structures. Results show that internal mobility allows the firm to staff higher-level jobs with workers who have better performance but are paid less." By detailing the strong advantage of internal mobility over external hires, he adds, "these findings help to explain the continued resilience of internal labor markets in the face of pressures for worker mobility."

Additional Reading
Ranking Employees: Why Comparing Workers to Their Peers Can Often Backfire: Knowledge@Wharton Should Performance Reviews Be Fired? Knowledge@Wharton

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theglobalroundhouse 47p 33 weeks ago Interesting. Insightful. This article delves into an HBR article on "plug 'n play" hiring; hiring externally, someone who can hit the ground running. The author of that article says "plug 'n play" is not advisable and this article examine why. Great cross reference. Wish I wasn't responding via my phone and could pass along the link. Must be a morale killer for internal employees to know external hires earn so much more. Seems to demonstrate a profits over people strategy (implicit) used by companies. Not good. I get the sense, intuitively and from the reading I do, people are tired of this. They want dignity (at least) in the workplace and to know their efforts are meaningful. Report Reply 1 reply active 22 weeks ago +1

Nicola Stratford 33 weeks ago Something for all firms and organisations to note. I'm going to share this around, especially with my union, so they can add to the research about the dangers of casualisation of the workforce and the emphasis on consultants, too. Report Reply +2

Martha 33 weeks ago Anecdotally, I have seen new hires motivated to get up to speed quickly while bringing a fresh perspective on how things could be done better, whereas existing employees can be lazy about making new connections and take a 'this is how we do it' mentality into whatever role they get

promoted into, rather than looking for innovation. And, in my experience, it's rare to see an existing employee willing to challenge the system, whether in deference to their colleagues, not wanting to stand out, whatever. So contrary to your study, I've seen new hires who were much more productive, and much more valuable, to organizations. Report Reply 2 replies active 29 weeks ago +3

Martha 33 weeks ago Also, performance reviews tend to favor compliant behavior. In other words, existing employees who have proven their willingness to not rock the boat. Report Reply +2

Alan Overton 33 weeks ago Nicely written. There is a related issue that I believe should also be considered. Internal hires bring competence in company systems and procedures, but less new knowledge. What internal hires know may be embodied in organizational structures and processes already, and therefore their competence can be recreated. I believe that organizations instead may seek to benefit from the cross pollination of internal and external ideas and that the benefit of this does not wholly inure to the department. This would explain 1) the observed predilection for external hiring in many corporations as a tacit or explicit organizational policy, 2) the premium salary paid to external hires (both to compensate for the risk of moving and to reflect the higher value of new knowledge and perspectives to overall firm objectives), as well as 3) the observed tendency of poor performance reviews for external hires, which may reflect the Darwinian friction between perspectives becoming personalized between employees and managers who do not directly benefit from, and may actually feel threatened by the larger organizational strategy. Greater communication of corporate objectives and reasoning might make these hiring scenarios less disruptive. However, if the organization can predict the amount of time it takes to harvest new knowledge for incorporation into their own systems, the lack of stability experienced by either the existing department or the newly hired personnel may represent a calculated cost that they choose to bear. Report Reply +2

Reem Y 33 weeks ago

I think the reason internal employees moved to another department do not outperform external hires is not so much a need for new skills as losing their key asset: knowledge of the people around them. You could count understanding the corporate culture and knowing how to work in the company as a skill. But knowing who to turn to for what information (and whom to avoid), having a mental map of the people around you, that's priceless knowledge. I think that's what makes the internal hires more efficient and what handicaps the external ones. And it's not something a new hire can find out through research or reading. It takes time. Report Reply 0

Barry Ackerson 33 weeks ago The lower performance for new hires and employees promoting to a new department is not surprising because it takes time to develop new skills. In the learning and development field this is known as the "J" curve of performance development. How long does it take for a newly promoted employee to develop the skills, knowledge, and abilities of a current incumbent? How does the organization support and encourage the development of new skills and knowledge? Also, I did not notice anything about the objectivity/bias of the rating system used. Could the expectations of the external hire be greater than the internal hire? Report Reply 1 reply active 33 weeks ago +2

Kenneth Armitage 33 weeks ago A report from the Association of Business Recovery Professionals (ABRP) some years ago suggested it was bad management, poor or weak leadership, clear lines of responsibility and accountability and a combination of poor financial management and planning, that accounted for more than 60 per cent of business failures in Britain, although that might apply in other nations. Because of the confused and often ineffective programme of fast-tracking individuals with paper academic qualifications many of those placed in supervisory let alone management positions lack actual hands-on practical experience of managing people, which is what management is primarily about. This particular weakness is exacerbated when people are elevated, sometimes through nepotism or cronyism, too quickly up the management tree to positions of responsibility and accountability for the actions and performance of others without knowing them and what they do. This particular situation is exacerbated when someone is brought in from outside because he or she has apparently been successful in another company when the facts do not support the rhetoric, and one has to wonder if the person jumped before he or she was pushed or if the company was only too pleased to lose them.

However, the apparent inability to understand the complexity of jobs undertaken by employees at the coal-face or on the shop-floor means that when programmes do not go as planned directors and senior managers often outsource investigations and reports and look for recommendations from management consultancies; and, these organizations are ones that tend to be staffed with supposedly bright young things who have very little practical experience of managing people and best management practice or understanding the businesses and culture of the companies they report on. The result is a 'merry-go-round' of costly advertising and recruitment programmes that see supposedly brighter people, often with inflated academic and professional experience, move from one company to another to progress their careers and climb corporate ladders but without actually contributing to and improving the performance and productivity of the companies they join for short periods. In the end it all boils down to the character, attitude, communication and performance of those brought in as to whether they will succeed. It is not 'Education, Education, Education' but 'Training, Training, Training' that should be the battle cry that must be applied to the process of training managers and also applied to the way in which companies are organized, structured and lead simply because the model of management, organization, structure and leadership in some companies and organizations is not only jaded but, because of greed, sleaze and nepotism, is tarnished. As Peter F Drucker suggested, No institution can possibly survive if it needs geniuses or supermen to manage it. It must be organized in such a way as to be able to get along under a leadership composed of average human beings. Report Reply +1

Andrew McFarland 33 weeks ago Paid more Companies trying to maximize profits will always tend to pay less for their existing team if they view that resource as "stable". When a companys actions give the impression that internal employees are valued less, turnover naturally increases which leads to an expensive cycle. Instead, pay employees market competitive rates. If the talent market becomes more competitive, companies ought to do better than a 1% pay raise. Perform worse In addition to the who you know factor, lower efficacy could also be due to rating bias in favor of the "devil you know." Human nature favors the familiar and is threatened by the competent. Report Reply +1

Kint 33 weeks ago

The authors said it, moved along, and apparently never noticed it: "get significantly lower performance evaluations". So not lower performance, lower evaluations. Take note, because an outsider will always need time to settle in and be accepted in an organization. On the author's point, the HR departments in their endless incompetence indeed look for what they "can" see, such as education and crap written in resumes, and fail to see what people with real jobs can see, such as how good a person may be for the position. Report Reply 0

Carmel 33 weeks ago This is very common in all organisation, it depends on the requirement like skill,knowlege,experience,competency,talent. Yes partially internal staff might be demotivated, but it also depends on lack of time for training the internal source for it and the emergency of the situation. Either the company should spend time in training the internal staff or already have a good Internal staff which avoids the organisation to hire External hires. Report Reply +1

Thomas 33 weeks ago There is in my experience also an infatuation with politicians with bringing in outsiders from the private sector to run Government departments who frequently struggle with the political complexities and constraints in the public sector This extends to preferring the advice of external consultants over in house public servants,when the consultants ,no fools , simply interview all the public servants and synthesize their views based on experience to advise governments who pay them big money for the advice Report Reply +1

yasin 32 weeks ago this means that companies continue to work with internal staff and have an aging work force external employees also bring in fresh ideas into the organisation while the old timer's are the most resistant to change having a healthy mix is always good Report Reply

Chandra Kant Saran 32 weeks ago A good, thought provoking article. However, I have a different view in the matter. Out of my experience, I have found that external hires are very good at challenging the status quo. This is essential to bring the existing employees out of their comfort zones to respond to the new challenges. This contributes in keeping the organisation's fabric 'fresh'. New avenues of smart working is evolved and adds up to growth and sustainability of the business. The performance of the external hires is not comparable with the internal staff, as only apple to apple should be compared. The external hires face more than obvious road bumps as they adopt non-con-formative style of functioning, causing perceived loss of credibility within the internal staff. We do need to embrace change that the businesses demand and it may come through external hires / Consultants. Report Reply +1

JeffreyAllenMiller 32 weeks ago I thought that my strategy was extremely old fashioned until reading this post. I have been trying for more than a year to secure an ''entry level'' internal communications job while recruiters are pushing me to apply for a director-level or vice president roles. I've managed, by this point in time, to piece together hiring managers' excuses -- they think that I'm way over qualified and that my salary requirements would blow their budget. How does one say "wrong'' on both? This article supports my philosophy of promote from within and hire out to replace that lowerlevel opening. Salary means nothing to me -- I trust my skills enough after 20 years to know for a fact the pay scale will improve in time. So, why isn't corporate HR on board? Report Reply -1

Paul Basile 32 weeks ago

There is no inherent logic in the notion that external people are less capable than internal people (in EVERY organization?) To think there is mirrors Lake Wobegon where "all the children are above average". The real problem with the performance of external hires is that recruitment processes are broken. External people are - of course - perfectly as capable as internal people, but selecting the right ones is done so consistently poorly that, voila, it appears that external hires are less capable than internal people. We can know just as much about external candidates as internal and, equally important, we can use that information to make high-likelihood predictions of future performance. But all too often, companies do neither. If external hires underperform, it's not the external-ity that is at fault, but the flawed processes that select them. Report Reply +1

@Chief_Connector 32 weeks ago "The author's point, HR in their endless incompetence indeed look for what they "can" see, such as education and crap written in resumes, and fail to see what people with real jobs can see, such as how good a person may be for the position." - On point with Kint's statement. We need more accessibility to structured interviews. It's time to move beyond resumes - groups like www.hrmc.com and www.hireIQinc.com Report Reply +1

Kunal 32 weeks ago This article clearly states the kind of biased attitude organisations hold for new hires. Although it is a noticeable fact that hiring someone from outside is more costly than promoting someone from inside the organisation yet, for the excuses like the external prospect has better education or experience , he/she can bring a fresh thought on how to do things are given. It is highly demotivating for internal employees who put their hard work and time in assisting organisations to earn profits when they are bypassed for someone hired externally. I would like to give my support for "promoting the employees internally" thought . An existing employee has better knowledge about the organisation, the work culture and people inside. Promoting internal employees bring stability and loyalty in the other employees. It promotes a healthy working environment, which in turn increase the employee satisfactions and we all are aware that if the employees are happy the customers will be happy too. Report Reply 0

Ajitha 32 weeks ago He is totally biassed towards int. .promotions. Not sure about his research validity Report Reply 0

Robert 32 weeks ago For the good of the company, I believe that it is imperative to have a mixture of both. To always promote internally lends more to doing the same things the same way with few exceptions. Still at the same time, internal promotions normally get up to speed faster because they know the company. External canidates bring fresh eyes and ears to the table, they are less tied to, "the way we have always done it." Yes, they take longer to get up to speed but their strengths lie elsewhere. The best system would be to have a diverse group based on the qualities that the job requires. Report Reply 0

Rohit 32 weeks ago This is the true story of all the Organization which does this. Organization always does this bias to the prompt employees in the organization. When asked why this difference? we are working on the same and soon the normalization on the packages will be shown. Report Reply 0

Ulki 30 weeks ago Very interesting article, thought provoking. Report Reply 0

Darin 29 weeks ago I am surprised about this article. I was a Contractor at a large company for several years, and while the Contractors make more money, it was very justified. It seemed to me that the majority of Internal Employees move from one position to another without actually being qualified, and

the Externals were hired at their position because they are very qualified. As a result, the Externals did nearly all of the work, and had to teach the Internals how to do their job, especially Managers because they move around more than anyone. I don't understand how other companies that hire Externals are any different. Report Reply 0

keen psychics 27 weeks ago An existing employee has better knowledge about the organisation, the work culture and people inside. Promoting internal employees bring stability and loyalty in the other employees. Report Reply 0

@SalarySchool 26 weeks ago My experience has led me to believe that his article, in conjunction with the previously referenced HBR "Plug 'n Play" article are spot on. There is no denying that, in moderation, an infusion of fresh ideas can add significant value to any organization. However, when an organization has employees that have jumped through multiple hoops to show their value to the organization, only to be denied promotions because a box on their skill set has not been formally checked, it can create an unhealthy environment. Likewise, if the organization hires newcomers that have all the right experiences (even if performance was sub-standard or not consistent with the demands of the new company) then one may be setting themselves up for failure.