How Acid Are Lemons? Adverse Selection and Signalling for Skilled Labour Market Entrants

A major incentive for human capital investments is the possibility to signal individual productivity gained by training not only to the present employer but also to the external labour market. There are only few empirical assessments of the capacity to signal the value of professional or occupational training, however. The most important reason for this gap in the literature is that training quality and employee productivity are not easy to measure. More specifically, prior tenure, unobservable ability and the business cycle usually have an unobservable effect on the market value of job applicants after training.

This paper for the first time presents evidence for negative selection and signals for employer changers. It uses the German dual apprenticeship system as an institution that allows us to analyse the value of signals after occupational training. Apprentices do not have prior employment experience and they are relatively homogeneous with respect to their age and schooling background given their occupation. In addition, they attend a highly standardised programme with three certificates at the end that help them to signal practical, theoretical and social skills. Finally, most apprentices start and finish their training programme at the same point in time and therefore cyclical labour demand and supply effects are the same when apprentices select themselves into a training programme and when they hit the labour market.

We distinguish signals from three sources: occupation, training employer and individual. There are quality differences between occupations and therefore we only compare apprentices with the same occupation and remove apprentices who work in a different occupation after they finish their apprenticeship from the data set. Employer changers nevertheless signal a different relative productivity when the occupational retention rate differs. A lower average productivity of employer changers can be assumed if employer changers are a negatively selected group because training employers know the quality of their apprentices and succeed in retaining their most able apprentices. This paper indeed shows that the higher the occupational retention rate the more negative the selection and therefore the higher the wage loss of employer changers. The same effect on entry wages for job changers is found for another group signal, the retention rate of the training employer – employer changers from a training firm that retains most of their employees experience a higher wage loss. In addition, the size of the training employer, a high average apprentice wage, and works councils are used as signals for training quality and induce a wage bonus for employer changers. Also according to the signalling theory, employer changers with higher schooling levels obtain a higher entry wage as skilled employees. This paper finally develops a measure for relative productivity of apprentices, their relative wage position. We argue that a wage bonus is paid voluntarily by the training firm in order to retain and motivate the most able apprentices. We indeed find that a high wage position leads to a higher chance to stay with the training firm. This again is an argument for negative selection of employer changers. In addition, a high wage position also leads to an increase in entry wages of employer changers in the new firm – obviously the (unobservable) wage position is positively correlated with other observable signals such as certificates.

Wagner, Robert and Thomas Zwick (2012), How Acid Are Lemons? Adverse Selection and Signalling for Skilled Labour Market Entrants, ZEW Discussion Paper No. 12-014, Mannheim.