Productive firms can better spot and deploy their internal talent

When a job vacancy opens, the manager faces a choice: to hire from outside the organisation, or to fill the position with an existing employee through a promotion or horizontal move. This column uses data from Finland to show that more productive firms are more likely to hire from within. As technological change reshapes jobs and the skills they require, the ability to recognise and redeploy existing talent may become increasingly valuable. The most productive firms may have an advantage not only because they have better workers or better technology, but because they are better at seeing the capabilities already inside their organisations.

Hiring decisions are among the most important choices that managers must make. Rapid technological change, including artificial intelligence, is reshaping tasks and the skills firms need, increasing the need to reallocate workers to jobs where their skills are most valuable. When a job vacancy opens, the manager faces a choice: to hire from outside the organisation, or to fill the position with an existing employee through a promotion or horizontal move. 

A related question is why some firms are persistently more productive than others. Firms differ substantially in their management practices, and better-managed firms tend to be more productive. Saporta-Eksten et al. (2017) show that structured management practices involving performance monitoring, target setting, and incentives are associated with productivity and other firm performance measures. Minni (2025) finds that good managers raise productivity partly by reallocating employees to better-fitting jobs.

Reliance on internal versus external hiring varies considerably across firms and jobs. Internal hiring is more prevalent higher in the job hierarchy and is related to other human resource practices such as training, recruitment, and screening (DeVaro 2020). But this literature has not asked whether the choice varies systematically with firm productivity.

Our research (Alonso et al. 2026) turns the usual productivity question around. Rather than asking how managerial practices and decisions affect productivity, we ask: do managers in more productive firms make different hiring decisions? 

We focus on the decision whether to hire internally or externally and document a new empirical pattern: more productive firms are more likely to hire from within. We then develop a new theory to explain this relationship. Our theory suggests that productive firms are better able to identify and deploy their internal talent.

Productive firms hire differently

We merge Finnish financial-statement and employer-employee data to estimate firm productivity and study its relationship with hiring. The data distinguish three ways to fill a vacancy: an internal promotion, an internal horizontal move, or a hire from another firm. We focus on vacancies in two white-collar groups: higher-level ‘professionals’ and lower-level ‘experts’. At either level, a vacancy can be filled internally by a horizontal move or a promotion from a lower level.

We find that as firm productivity increases, external hiring becomes less likely and internal hiring more likely. For higher-level professionals, the shift toward internal hiring is driven primarily by horizontal moves. A one-standard-deviation increase in firm productivity is associated with a 2.2-percentage-point increase in the probability of an internal horizontal move and a 2.9-percentage-point reduction in the probability of external hiring. Relative to the frequency of these types of moves, these changes are about 6% and 8%, respectively.

For lower-level experts, by contrast, the pattern operates mainly through promotion. Moving from low- to high-productivity firms is associated with a pronounced increase in the probability that an expert vacancy is filled through an internal promotion. A one-standard-deviation increase in productivity is associated with about a 5-percentage-point increase in the probability of internal promotion – roughly a 17% increase relative to the frequency of promotions – and a 4-percentage-point reduction in external hiring.

Figure 1 Firm productivity and the probability of internal and external hiring

A) Higher-level professionals

B) Lower-level experts

Note: The figure plots predicted probabilities of internal horizontal moves, internal promotions, and external moves across deciles of firm productivity.
Source: Alonso et al. (2026).

Figure 1 reveals the common pattern: the higher the firm’s productivity, the less likely it is that a vacancy is filled by bringing in someone from another firm. But why?

A clearer view of internal talent

One explanation is that firms typically know more about internal than external candidates. For external applicants, information may be limited to education, experience, credentials, references, and an interview. For internal applicants, firms may have accumulated years of information from performance evaluations, past assignments, supervisors, co-workers, and performance on related tasks.

But the fact that information about internal talent resides within the organisation does not guarantee that it can be readily accessed and used. Better-managed firms are more likely to have systematic performance monitoring and appraisal processes and communication systems that make information about employees available throughout the organisation. Prior research shows substantial differences across firms in these kinds of structured management practices (Bloom et al. 2019). Such systems can give hiring managers a clearer picture of the internal talent pool.

Our theoretical framework formalises this idea. Suppose a manager filling a vacancy considers both internal and external candidates but observes each candidate’s potential match with the job only imperfectly. Better screening of the internal pool gives the manager a clearer picture of each internal candidate’s suitability for the job.

At first glance, it is not obvious that better screening should lead to more internal hiring. Better information could reveal that an apparently promising internal candidate is actually a poor fit. But better screening also allows managers to make sharper distinctions among internal candidates. When screening is poor, an outstanding internal candidate may not look very different from a mediocre one. When screening improves, the outstanding candidate stands out more clearly. Under conditions likely to characterise typical hiring situations, this increases the probability that the best candidate identified across the competing applicant pools comes from inside the organisation. In short, better information makes it easier to spot an internal star.

What else should we observe if this mechanism matters?

Our data lack direct measures of firms’ management practices, so we cannot definitively establish that better internal screening causes the relationship between productivity and internal hiring. But we can examine whether other patterns predicted by our theory appear in the data. Several do.

First, our framework predicts that firms should be more likely to hire internally when they have a larger internal applicant pool. We find this pattern for both professionals and experts.

Second, our framework predicts that the quality of the internal applicant pool should matter. Using educational attainment as an indicator of applicant quality, we find evidence consistent with this prediction, although the relationships differ across job levels and hiring channels.

Third, if superior management helps firms evaluate internal talent, firms with better-performing managers should rely more on internal hiring. Our evidence is consistent with this prediction. Among higher-level professionals, internal horizontal moves become more likely as managerial performance increases; among lower-level experts, external hiring becomes less likely. A one-standard-deviation increase in managerial performance is associated with a 4-percentage-point change in each of these predicted probabilities.

Taken together, these findings are consistent with the idea that productive firms have an informational advantage in their internal labour markets.

Internal labour markets as information systems

Internal labour markets are often viewed as career ladders. Workers enter an organisation, accumulate experience and skills that may be particularly valuable within that organisation, and move through the internal job hierarchy. Firms benefit by retaining valuable employees, while employees benefit from career advancement opportunities.

Our results point to another role of internal labour markets. An internal labour market is also an information system. As employees work for an organisation, the firm accumulates information about their abilities, performance, and suitability for different jobs. The value of that information depends on whether managers can collect it, communicate it, and use it effectively when vacancies arise.

This perspective also complements recent evidence on the allocative role of managers. Minni (2025) finds that good managers improve productivity by moving existing workers into better job matches. Our results suggest a related mechanism operating at the boundary between the internal and external labour markets: productive firms are more likely to fill vacancies internally.

This does not imply that external hiring is a mistake. External recruitment can introduce new skills, knowledge and ideas, and sometimes the best candidate really is outside the organisation. Indeed, better screening is valuable precisely because it helps managers distinguish when an internal candidate is exceptional and when an external candidate is preferable.

The broader lesson is that firms’ ability to identify talent may matter alongside their ability to attract it. Investments in performance management and internal communication may therefore have benefits extending beyond monitoring and motivating workers in their current jobs. They can improve the information managers use when deciding who should do what next.

As technological change reshapes jobs and the skills they require, the ability to recognise and redeploy existing talent may become increasingly valuable. The most productive firms may have an advantage not only because they have better workers or better technology, but because they are better at seeing the capabilities already inside their organisations.

Source : VOXeu