The Determinants and Implications of Firms' Workforce Composition: The Case of Home Health

This paper presents and tests a new model that highlights the role of reputation in determining firms' workforce composition and strategy. Facing demand uncertainty, firms in labor-intensive service industries, such as health care, often rely on temporary workers. Past research has shown that firms that employ more temporary workers when facing greater demand fluctuations. However, this strategy is challenged by accumulating evidence that permanent and temporary workers are not perfectly interchangeable in the production of quality. This paper examines the strategies of firms facing this trade-off: temporary workers provide flexibility in responding to demand fluctuations but can lower reputation through a decline in quality. Through a model where demand is stochastic and linked to firms' reputation for quality, this paper predicts that firms' workforce composition depends on their reputation. Using novel and rich data from a large multi-state US home health provider, I provide evidence consistent with the theory. First patients visited more by permanent nurses were less likely to be rehospitalized. I use patient's differential distances to the nearest proportion of permanent nurse visits. Second, measuring firms' reputation by the establishment of a strong referral base, I find that low-reputation firms, such as new firms, decreased the share of temporary nurses with demand fluctuations. These results imply that low-reputation firms forgo short-term profitability in favor of long-term reputation gains through improvements to service quality.