Personnel Economics

1
Chapter 11

• Personnel Economics

2

• Introduction
• How do firms use compensation strategies to
  achieve profit maximizing outcomes?
• How can employers motivate workers to achieve
  more productivity?
• How do compensation systems encourage the right
  potential worker to apply for work in the firm?
• Why does the law of one price not hold in labor
  markets

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• Motivating Worker Effort
• The major job of the manager is to elicit effort
  from workers
• The problem is recognized in the principle-agent
  (PA) problem How does the principle (employer or
  manager) get the agent (the worker) to perform in
  a way consistent with the principles interests?
• Agents have their own priorities
• Productivity isnt always easy to measure
• Shirking can be concealed
• Understanding the PA problem can help us
  understand why jobs exist, why employment and
  wage hierarchies exist, etc.

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• Wages and the Supply of Effort
• Workers gain utility from Wages and disutility
  from effort
• Uf(Wages, Effort)
• U1ltU2ltU3
• Workers take into account wages and effort levels
  to determine if a job is acceptable
• It may be that workers earn different wages based
  on non-monetary characteristics such required
  effort
• Workers have an incentive to shirk they get to a
  higher utility for a given wage by reducing
  effort
• Managers have to expend resources to monitor
  workers to prevent shirking
• The structure of compensation may also be used to
  prevent shirking

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• Effort and Output in a Fixed Wage System
• Individual Production Function
• Q?E v
• Production is a function of effort plus the
  effect of factors beyond the workers control
• Examples of jobs where ? is low and v is high and
  vice versa
• If the wage is fixed, E1 might be the minimum
  effort necessary. It covers the wage plus a
  mark-up to cover the normal rate of profit
• Suppose the w is equal to the going wage in the
  labour market, the threat of firing for shirking
  may not be effective
• How do managers elicit E2 amount of effort?

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• Performance Pay
• w-B?E
• Bperformance bond to get the job
• Only those with indifference curves above E1 will
  take a job of this sort (see pg 290).
• The rest can do better by taking a job that pays
  w1 without having to pay a performance bond
• Advantages
• Encourages self selection or workers who will put
  in the effort
• Managers dont have to monitor workers as much.
  Workers who shirk will move to a lower
  indifference curve

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• Effort linked to Output rather than Performance
• See pg 292
• If output less than q1, wage w0
• If output greater than q1, wage positively
  correlated with output
• A worker who is at q1 or below when other workers
  are above reveals himself/herself to be an
  inferior worker and is discharged
• If all or most workers are on the flat portion,
  then it is economic circumstances not individual
  effort that is causing the low output

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• Difficulties in Implementing Performance Pay
• Difficulty in measuring individual output
• An extended length of time to measure performance
  in some instances
• Output is not dependent on individual effort
• Multi-tasked jobs base incentives on all
  activities
• Some performance based systems subject to
  manipulation. Peer pressure for slow-down, etc.

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• Work-life Incentive Systems future wage levels
  are contingent on satisfactory job performance
• Basic Concepts
• Objective increase effort, reduce incentive to
  shirk
• Raise cost of shirking by raising potential lost
  income that occurs if one is caught and fired
• Graph page 296
• Wage is below VMP (that is productivity)early,
  but above VMP later in ones career (present
  value of W and VMP the same, however)
• w represents the best alternative combination
  of wage and utility derived from nonwork income
  and leisure available to the worker
• w diverges from w suggesting that workers might
  hang on even after they are not very productive
  (buyout schemes maybe necessary)

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• If paid VMP, the incentive to work hard
  diminishes
• If paid w the incentive to work hard stays in
  force because the penalty of getting caught
  shirking (w-w) remains high
• Probationary Period
• Objective encourages only workers who can
  consistently peform up to a given standard to
  apply for the job.
• Period during which new worker proves
  his/productivity. Probationary wage usually set
  well below VMP, post-probation wage substantially
  higher
• Only workers who have a high probability of being
  retained will find it worth it to take the low
  initial wage in order to qualify for the high
  post-probationary wage.

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• Tournaments and Promotions (w diverges from w
  based on performance in tournament)
• A hierarchy of jobs, where a promotion with
  substantial pay increases goes to the highest
  performer.
• Three features
• Promotions are prizes in the tournament
• Prize goes to best performer. Relative measure or
  performance rather than absolute measure.
  Controls for variations in outside circumstances
• A significant salary increase goes to the winner
  (high salary or CEO is motivational device)
• Drawbacks
• not a good system if you want competitors to
  cooperate.
• Resources wasted on lobbying

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• Another Wage Policy Model
• Efficiency Wage (EW) Firms intentionally set
  wage above the market clearing level, which may
  cause unemployment.
• Contrasts with work-life incentive (WLI) model
  because the wage level is set above equilibrium.
  That is,wVMP in WLI model whereas wgtVMP in EW
  model
• Incentives for performance or to reduce
  monitoring costs by raising cost to worker of
  losing job
• Increase job tenure to save on recruitment and
  training costs
• To attract a better pool of applicants (avoid
  adverse selection)
• Deter union activity
• Increase morale