1. ECON 308: Employment Decisions
Chapter 14 Attracting and Retaining Qualified Employees Chapter 16 Individual Performance Evaluation Week 14: Nov. 30 , 2012

2. Attracting & Retaining Employees
Principles:
Maximum Value: Marginal Revenue Product (willing to pay)
People won’t come to your firm until you make them at least as well of as the could be elsewhere (Opportunity Cost: Have to pay)
Paying more than is needed to attract employees puts a firm at a competitive disadvantage
It is in the interest of both employee and firm to maximized the value created in the relationship

3. Chapter 14 Organization No-frills Competitive Labor Market
Some complications
Human Capital
Compensating Differentials
Costly Information
Internal Labor Markets
The Salary-Fringe Benefit Mix

4. No-Frills Competitive Model
Labor market is competitive
no discretion over wages
Market Wages are costless to observe
Workers are identical
Jobs are identical
All labor is rented on the spot market
All compensation is monetary

5. Basic Competitive Model
Wage in $
Market Wage Rate
Marginal Revenue Product of labor E E*
Number of Employees

6. Human Capital Terminology Human Capital: Skills
Investment in Human Capital: Education, OJT
“rate of return” on Human Capital: MB > MC
Types of Human Capital
General (Excel, Word, text messaging)
Firm Specific: (proprietary software)

7. Compensating Differentials
Consider 3 Welding jobs
Job X pays $8/hour in clean, air-conditioned safe working conditions,
Job Y pays $8/hour in a dirty, outdoor construction site,
Job Z pays $8/hour in ship construction yard.
Is this an equilibrium wage?

8. Compensating Differentials
Must pay more when a job has undesirable characteristics
$ more must by paid for every 1/10,000 increase in the probability of being killed on the job
A firm with 1,000 employees could reduce wages by $20,000-$300,000 per year by preventing one accidental death every 10 years.
Knowledge of necessary CD  how to invest in alternatives: safety devices

9. Compensating Differentials
Implications
Unpleasant jobs get done
Companies are rewarded for making jobs more pleasant
Workers may choose the level of risk they wish to face

10. Compensation Information: Costly to acquire
Compensation may be hard to see
Workers differ in human capital so they may differ in the compensation offered
Firms don’t share all of the details of compensation with prospective employees
Symptoms…
…of over-paying: too many qualified applicants
…of under-paying: few applicants, high turnover

11. Problems with under-paying
Low compensation is associated with high turnover so costs of re-training are high
When turnover is high there may be incentive problems

12. Internal Labor Markets
Hire at entry level, promote from within
Law Firms, Accounting Firms, Hospitals
In 1991 an employee between 45 & 54 had typically been with the same employer for 10 years or longer
Half of all men and ¼ of women stay with the same firm at least 20 years
Most Internal Labor Markets rely on implicit contracts

13. Tradeoffs in Long-Term Employee Agreements
Benefits of internal labor markets
Accumulates more firm-specific human capital
Better motivation
There is incentive to avoid behavior that is dysfunctional in the long run
Managers know more about employee attributes
Costs of internal labor markets
Restricted competition for advanced jobs

14. Pay in Internal Labor Markets
Compensation
Salary
Marginal Revenue Product of Labor
Tenure with the firm

15. Tradeoffs with Career Earnings
Advantages
Efficiency wages reduce turnover and shirking
Since pay rises faster than MRPL employees have strong incentives to make the firm look good
Promotions become a reward for good behavior
Disadvantages
Promotions may be manipulated because of destructive behavior toward other rivals
Promotions are a crude incentive tool since they are infrequent
The Peter Principle: People rise to level of incompetence
Much time may be spent lobbying managers for promotions

16. The Salary-Fringe Benefit Mix
Fringe Benefits account for about 25% of compensation for the average American
Examples
Health Insurance
Non-Social Security pension programs
Subsidized Education
Discounted Meals

17. Indifference Curves Between Salaries and Fringe Benefits
Monetary Compensation
Utility = U2
Utility = U1
Fringe Benefits

18. Iso-Cost Lines Between Salaries and Fringe Benefits
$50 K
Iso-cost line at $50,000 ($50K) of total payment
Monetary Compensation
Slope = -1
$50K
Fringe Benefits

19. Optimal combination: Salaries and Fringe Benefits
$50 K
Monetary Compensation
$30K
$20K
$50K
Fringe Benefits

20. Fringe Benefits Payroll taxes Make the iso-cost line flatter
The total tax-bill (including the part paid by the employees) will matter in determining the optimal mix of fringe benefits
Applications
Fringe benefits can be used to screen for particular types of employees
Cafeteria-style plans are desirable when administration costs are low and when adverse selection is not a problem.

21. Chapter 16: Individual Performance Evaluation
ECON 308
Chapter 16: Individual Performance Evaluation
Week 14

22. Performance Evaluation
Evaluations provide employees feedback on achievement and ways to improve
Evaluations are used to determine rewards and sanctions
Performance evaluation entail evaluating employees as well as subunit of the firm
16-22

23. Implicit Assumptions Principal knows agent’s production function
Output is single quantitative measure of performance
Output can be observed at zero cost
Employee cannot game the measure
Employee produces a single output
Mutually beneficial contract is feasible
Employee works independently
16-23

24. Setting Performance Benchmarks
Time and motion studies
Engineers estimate the amount of time a task requires
Determines most effective work method
Past performance and ratchet effect
Employees have incentives to only meet the goal and not exceed it
16-24

25. Measurement Costs Accounting system may need to be developed
Information systems improved
Value-maximizing firm improves measures as long as incremental benefits justify costs
16-25

26. Opportunism Gaming Horizon problem
Employees may engage in dysfunctional activities to improve their evaluations
Horizon problem
Short-run objective performance measure may cause employees to focus on results that influence their evaluation only over their remaining time with the firm
16-26

27. Relative Performance Evaluation
Evaluate worker output relative to their co-workers in the same job
Within the firm
jobs not always identical
group has incentive to punish “rate busters”
incentive to hire less competent workers
Across firms
data hard to obtain
16-27

28. Subjective Performance Evaluation
Firms often use subjective evaluation along with objective measures
Multiple tasks and unbalanced effort
Workers have incentives to concentrate on activities that are easily measured
The subjective measure will allow the supervisor to determine cooperation and other difficult to measure activities
16-28

29. Subjective Evaluation Methods
Standard rating scales
Rank employees on various performance factors
Goal-based systems
Set annual goals and then measure whether the employee achieved them
Frequency
Often more frequent reviews are too costly
May be beneficial with new hires
16-29

30. Problems with Subjective Evaluations
Supervisor shirking
Forced distribution
May result in good employees being evaluated poorly
Influence costs
Reneging
16-30

31. Combining Performance Measures
Few job performance measures are purely objective or subjective
Both types can be inaccurate
increasing inaccuracy of either places greater weight on other
inaccuracies increase employee risk
Both can induce dysfunctional behaviors
16-31

32. Comparing Individual and Team OutputQ
Conrad and Dina’s team output
Sum of Conrad’s and Dina’s individual outputs
Expected output 25 e
2.5
Conrad’s and Dina’s individual effort levels
16-32

33. Government Regulation of Labor Markets
Anti-discrimination regulations dictate clear performance evaluation systems
May be inconsistent with value maximization
16-33