Reasons for Tenure: Incentive for Investment
At the law lunch today we discussed reasons for tenure. MA advanced this idea. Suppose that you need to invest X to become expert in research. If you do, you will be able to do research your entire life with probability .9, but with probability .1 you will be able to do it for 10 years and then lose the ability. This means that to get people to make this investment, we need to guarantee them a job even if they lose their ability, not because of risk aversion, but merely to make the investment profitable.
This sounds flawed to me. Think about the reward for the investment. There are two ways of giving people the incentive to do invest in expertise. One way is to pay them their value if they continue to do research– call it V– and otherwise to fire them, in which case they will earn some amount W in an alternative occupation which does not require the expertise. If universities compete, they will pay the full V to successful researchers. The value of that career path to the worker is .9V + .1 W - X. If they did not try for a research career in the first place the person would earn W, so for anyone to invest in expertise requires that .9V+.1W - x >= W, so .9(V-W) >= X. If that’s not true, it would be inefficient to have people acquiring expertise.
The second way to reward people is to give them a fixed wage of Z whether they lose their ability or not. That has payoff Z-X to the professor. Competitive universities would set Z equal to the expected output of the professor. Thus, .9V = Z.
Thus, under the first system, the professor gets a .9 chance of V and a .1 chance of W, an expected value of .9V + .1W -X, while under the second he gets .9V-X. He would prefer the no-tenure system if he is risk-neutral. Only if he were risk averse enough would he prefer a sure .9V to a 90-10 gamble between V and W.
I haven’t read the paper MA just referred to me, though:
Jaggia, Priscilla, and Anjan Thakor, 1994. “Firm-Specific Human Capital and Optimal Capital Structure,” International Economic Review, v. 35(2):283-308.