Five years ago, I posted a blog on award-winning research showing that firms pay more and get less when hiring from the external labor market. The reason is that managers know more about their current employees, and they overestimate the value of external hires because they focus on their formal qualifications. When it comes to filling jobs internally in the organization, a manager still has to choose between placing a known worker into a job or posting the job and assessing applicants, who may or may not be familiar to the manager. With internal hiring, do managers still undervalue the workers they know?
Research in Administrative Science Quarterly by JR Keller answers that question. He looked at the difference in job performance and pay between jobs that were filled through posting and applying, and jobs that were filled through the manager picking someone (slotting). Managers could choose which way to fill each job, and naturally they used slotting when they knew someone who fit and posting when they were not so sure. This is the same as choosing between internal job mobility and the external job market, because managers pick internal candidates when they know someone who fits the job and hire externally when they are not so sure. They also have more candidates when posting, and they know less about the applicants because they are usually from other parts of the organization. In every way you can imagine, the choice between posting and slotting is similar to the choice between external and internal hiring.
So how wrong is it to fill an internal hire through posting instead of slotting? Here is the surprise: It is not worse to fill by posting, but better. Posting means higher job performance, both absolute and compared with others. It means lower chance of leaving the job, except for leaving for a promotion, which is more likely when filling through posting. Oh, and it also means higher pay for the employee filling the job. So, for the employee this looks like a good thing; more pay and better chance of a promotion. For the firm, it looks like paying more to get more, so the net effect depends on how much more the firm is getting. In this case the answer is easy because the lower turnover from the job alone shows that the firm benefits from using posting. The better job performance is icing on the cake.
But this raises the question of why markets work better inside an organization than outside it. What is it that the manager can see better when posting internally? The answer is, nearly everything. Organizations know a lot about their employees, and this knowledge is readily available when filling jobs through posting. Not only that, the posting process forces the hiring manager to think carefully about what information to use and how to weight it in the decision, giving a more systematic and higher quality choice. All the information is there, and posting gives more choices and a better choice process.
There is an important lesson in this that goes beyond filling positions. We often have beliefs about the benefit of markets relative to social arrangements like networks. We forget that there are many kinds of markets and many kinds of social arrangements, and ultimately decision making comes down to what to choose from and how to make the choice.