Why Top Firms Hire Exceptional Talent Only to Let Many of Them Go Later

Elite consulting firms, investment banks, major law practices, and other high-prestige professional workplaces have long been known for a pattern that seems counterintuitive at first glance: they hire some of the brightest young professionals, invest heavily in their training, and then push a large portion of them out just a few years later. A recent study published in the American Economic Review digs deep into this phenomenon and argues that this seemingly harsh practice is not a mistake or an unintended flaw. Instead, it may actually be the very mechanism that makes these firms function efficiently in industries where reputation, competition, and information asymmetry shape everything.

Below is a straightforward breakdown of what the study found, why these firms operate the way they do, and how this “up-or-out” cycle affects both companies and employees.

How Elite Firms Become Intermediaries of Talent

The study, conducted by financial economists Ron Kaniel from the University of Rochester and Dmitry Orlov from the University of Wisconsin–Madison, focuses on industries where client trust depends heavily on perceived employee skill. This includes consulting, law, asset management, auditing, and even architecture—fields where clients cannot easily judge expertise without some external signal.

In these industries, a firm serves as an intermediary. It hires young employees (referred to in the study as managers or agents), evaluates them internally, and markets their services to clients who otherwise have no reliable way of determining whether a worker is highly skilled.

At the beginning of an employee’s career, the firm knows much more about the worker’s talent than any client can. Because of this informational imbalance, employees often receive standardized early-career pay, even if their true skill is above average. They simply don’t yet have a way to credibly prove their ability to the outside world.

The researchers label this phase a quiet period, a time when firms keep employees who meet expectations and pay them fairly typical wages. But this quiet period does not last.

Why Firms Start “Churning” Even When Employees Perform Well

As an employee’s work becomes visible—successful cases, strong project outcomes, profitable investment choices—clients begin to form their own assessments. Slowly, the firm’s private knowledge advantage shrinks. Once clients can observe an employee’s track record, the firm loses the ability to keep paying them less than their market value.

This is where the firm’s strategy shifts into what the researchers call churning, or letting go of some employees who might still be quite talented but fall slightly below the top performers.

Churning isn’t about failure. It’s about maintaining the firm’s reputation and bargaining power. When clients start to realize which employees are strong performers, the firm needs a way to differentiate the very best from the merely very good.

By letting go of some good employees, the firm sends a strong external signal: the people who remain are exceptional.

And for those who were let go? To the outside world, their performance appears just as strong as their peers who stayed. Their departure doesn’t brand them as poor performers. If anything, their time at an elite firm becomes a quality stamp that boosts their credibility outside.

Why Employees Accept Lower Pay at Elite Firms

One of the most interesting insights from the study is the idea that employees who stay on at these top firms often end up being underpaid relative to their true value—but they willingly accept it.

Here’s why:

Remaining employed at a prestigious firm becomes a powerful career signal. It tells the market that they are among the strongest in the talent pool. This gives them the ability to earn significantly more later when they leave and begin working directly with clients or move to high-status competitor firms.

In other words, the temporary underpayment becomes a strategic investment. The prestige of sticking around is worth more than the immediate compensation gap.

Meanwhile, the firm benefits too. By holding the threat of dismissal over employees—especially after churning begins—it can keep wages lower without losing its top performers. Workers know that being fired later in the cycle could lead outsiders to assume they were the lowest-ranked among the group, even if they were still very talented. That incentive keeps them in place and compliant.

The end result is what the researchers describe as a stable equilibrium, where both the firm and the employees get something valuable out of the arrangement.

Why the System Works So Well in Certain Industries

This model fits best in fields where:

• individual performance is publicly visible,
• talent is a primary determinant of client outcomes,
• reputation significantly affects pricing power, and
• clients cannot easily judge skill without external signals.

In consulting, law, finance, auditing, and architecture, firms are effectively in the business of selling trust. Clients don’t buy a report, or a contract, or a pitch deck. They buy the assurance that the professionals working behind the scenes are truly top-tier.

To maintain that reputation, the firm must constantly demonstrate that it employs only the highest-quality people. Churning becomes a natural way to send that message.

This also explains why these firms attract so many ambitious young workers despite:

• long hours,
• heavy workloads,
• intense competition, and
• starting pay that doesn’t always match effort.

The tradeoff is clear: sacrificing short-term comfort for long-term career advantage.

What Happens to the Employees Who Leave

One of the reassuring insights of the study is that being let go by an elite firm is not a mark of failure. Often, these employees go on to thrive in:

• boutique firms,
• in-house positions,
• entrepreneurial ventures,
• or direct client work.

Clients view their previous affiliation as strong evidence of competence. And since outsiders can’t differentiate between the “top of the top” and the “still very good,” many former employees find that their time at a prestigious firm becomes a long-lasting career asset.

Broader Implications of the Study

Beyond just explaining turnover, the findings challenge traditional assumptions in labor economics. They suggest that:

• high turnover at top firms may be economically rational,
• firing good employees can actually benefit everyone involved,
• internal and external reputations drive compensation patterns, and
• attrition systems may arise naturally when information imbalances exist.

It’s a fascinating reminder that what looks unfair or inefficient from the outside might actually be part of a well-tuned market process.

How This Model Connects to Broader Labor-Market Concepts

To give readers more context, here are some related concepts that help explain why elite firms behave this way:

Asymmetric Information

This occurs when one party has more information than another. In early career stages, firms know more about a worker’s ability than clients do. Over time, that gap closes, triggering changes in compensation and retention.

Signalling Theory

Holding a position at an elite firm is a powerful signal of competence. Just like graduating from a top university, staying at a top firm tells the market you’re highly capable.

Up-or-Out Systems

Many top firms formally use this approach, where employees must either rise in rank or leave. This study provides an economic explanation for why such systems persist.

Reputation Economics

A firm’s brand value depends heavily on client perception. Churning becomes a reputational maintenance tool.

These perspectives help us understand why the model presented in the study fits so neatly into real-world professional ecosystems.

Research Paper:
Intermediated Asymmetric Information, Compensation, and Career Prospects
https://www.aeaweb.org/articles?id=10.1257/aer.20200169