Suppose your firm has a mediocre employee.  He’s not ridiculous, but he’s worth a lot less than you pay him.  What does your firm do?

Econ professors’ knee-jerk answer is, “Fire him.”  But people with real jobs often notice a rather different reaction: Instead of firing the mediocre employee, his boss tells him, “You need to find other opportunities.”  The worker then has 1-3 months to search for another job, free of the stigma of current unemployment.  In HR jargon, the firm “dehires” him.  This how-to guide explains:

Managing a problematic employee is time consuming and negatively affects
the cohesion of your fitness team. Unfortunately, hoping that a
troublesome employee will just go away is not always realistic and may
even make the situation worse. Instead of backing away from the problem,
take action. By learning how to “de-hire,” you may never have to fire
anyone again.

[…]

Begin the conversation with statements such as “Sue, it appears that
Club X is really not the place you want to be working. You have been
calling in sick and arguing with members. Perhaps you’re not happy
teaching here any more?” “Sue, are you truly happy at Club X or do you
feel you might need a change?” or “Sue, it doesn’t appear that you want
to be part of the team anymore. Why don’t you think about what you want
to do and let’s meet again tomorrow.”

Dehiring has two main advantages over firing.  First, it is legally safer.  Employees who leave of their own volition to take another position are far less likely to sue you than employees you kick to the curb.  Second, it is psychologically easier.  When a firm fires a worker, his boss and co-workers feel sorry for him.  When a firm dehires a worker, his boss and co-workers feel happy for themselves!  No wonder the subtitle of the how-to guide is: “Don’t fire. Learn to de-hire to create a win-win situation for you and your employee.”

On reflection, though, dehiring is only “win-win” for the firm and the worker.  What about the problem worker’s next firm?  Dehiring is a nefarious plot between the worker and his current firm: “If you help me find another job, I’ll become their problem instead of yours.”  From the standpoint of the next employer, calling dehiring “win-win” is a sick joke.  The proper description is “win-win-lose” – the worker wins, the old firm wins, the new firm loses.

The prevalence of dehiring is another reason why educational signaling matters despite employer learning.  Suppose workers become transparent to their employers after a year on the job.  If firms summarily fire subpar performers, educational signals wouldn’t matter long.  But if firms with subpar workers drag their feet, then dehire, educational signals can matter indefinitely.  The mediocre workers moves from firm to firm, gradually exhausting the pity of his employer and co-workers.  As long as he looks good on paper, everyone who knows the mediocre worker’s true colors can escape by passing the buck to another unwitting employer.

Is there anything the government could do to ameliorate this problem?  Sure.  The government could mandate disclosure: If another employer inquires about your current or former employee, you must reveal everything negative that you know about him.  If you lie – or simply hold back – an employer who detrimentally relies on your reference can sue you for fraud.

As is often the case, though, actual government policy deliberately amplifies market inefficiency rather than mitigating it.  Existing law doesn’t punish firms for concealing negative information; it punishes firms for revealing negative information.  The results are sadly predictable: Employers fear to hire – and when they do hire, verifiable credentials matter more than the dubious words of the people who already know the truth.