McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Attracting and retaining qualified employees Personnel economics

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Attracting and retaining employees learning objectives Explain the fundamental operation of labor markets, including wage determination, as well as the concepts of compensating differentials and human capital Explain the role and structure of internal labor markets, including the concepts of firm- specific human capital and efficiency wages

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Benchmark model of employment and compensation Assumptions competitive labor market –wages determined by supply and demand current market wages costless to determine all jobs identical no long-term contracts –all labor hired in “spot” market all compensation is monetary

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The competitive model of employment and wages Each firm hires until MRP=market wage –firm paying less than market wage can’t fill positions –firm paying more than market wage is at cost disadvantage

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Relaxing the benchmark assumptions All jobs are not identical –employees will choose most desirable job for given level of pay –firms must offer compensation for undesirable characteristics (compensating differential) Workers are not perfect substitutes Information is costly Compensation takes many forms Jobs may be long term

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Internal labor markets Some firms may pay efficiency wages –compensation higher than market rates –can motivate workers not to shirk –may reduce turnover Compensation typically rises with seniority –higher productivity –incentive to work in best interest of firm, acquire firm-specific human capital

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Upward sloping earnings profile

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Promotions as tournaments Employees compete for promotions within organizational hierarchy Promotion systems have drawbacks –undermine cooperation –more discrete than monetary rewards –Peter principle may apply –employees may not value promotions –influence costs may rise

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Compensation components salary and fringe benefits Salary and fringe benefit compensation are not perfect substitutes for employees –the role of taxes –groups may purchase fringes at lower price Employees may wish to trade between salary and fringes to attain optimum combination

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Employee preferences for salary and fringe benefits

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Employer preferences for paying salary or fringe benefits

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. The optimal mix salaries versus fringes Maximize firm value by meeting potential employee’s reservation utility at lowest cost Indifference curve is tangent to an isocost line

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Optimal mix between salary and fringe benefits

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Optimal choice of salary and fringe benefits with payroll taxes

McGraw-Hill/Irwin © 2004 The McGraw-Hill Companies, Inc., All Rights Reserved. Attracting particular types of employees with the salary-benefits mix