Personnel Economics: Incentives and Compensation

• The notes cover sequential games, tournaments, efficiency wages, team incentives, comparison of incentive schemes, executive compensation, performance evaluation, adverse selection, signaling, search, bargaining, training, and benefits within the context of personnel economics.

Tournaments

• Tournaments serve as a motivational tool.
• Include multiple examples.
• A model of a tournament is presented.
• The concept of optimal effort is looked at for an individual worker.
• Competition between workers is explored as well.
• Larger prizes may not always induce more effort.
• Pay for performance can be implemented through pay structures in hierarchies.
• The Peter Principle says those who are good at their job will get promoted, until they are no longer excelling because they have hit their ceiling.
• Promotion from within is compared to hiring from outside
• Tournaments consider situations where one worker has an advantage.
• This may be due to ability differences.
• Favoritism also plays a role.
• Influence activities may arise.
• Such as sucking up, backstabbing, and misrepresenting information.

Efficiency Wages

• Provides a method of keeping employees incentivized and working hard.
• A Model of Efficiency Wages is explained.
• Repetition can be implemented.
• Harsh punishment may be used.
• Repetition and harsh punishment together are also effective.
• Restrictions on the firm’s behavior are important.
• Restrictions on wage reductions need to be considered.
• Restrictions on firing are also a factor.
• Unemployment insurance is relevant.

Team Incentives

• Looks at how teams are effective and incentivized.
• Teams are effective due to complementarities.
• Also identification of contributions.
• Knowledge transfer also occurs.
• Fairness within the teams.
• Three Approaches to Analyzing Teams are looked at.
• A game-theoretic approach is one way that is looked at for teams.
• A public goods approach is also used.
• A mathematical approach is reviewed as well.
• In addition, profit-sharing and gain-sharing are also effective.

Comparison of Incentive Schemes

• Getting workers to work is crucial to the efficiency of the company.
• It is important to know when to use the different schemes.
• How to know who gets the surplus.
• You can compare the problems to determine the best scheme to use.
• It is important to choose the right incentive scheme, and there are a variety of examples of this looked at to find the best scheme to use.
• This includes consideration of technical support operators.
• There is also college football coaching staffs that are looked at.
• And finally, dental hygienists.

Executive Compensation

• This section evaluates how to best compensate CEOs and other executives
• A few examples of compensation packages.
• Aligning the CEO’s and the Owners’ Interests is crucial.
• Compensation through Stock vs. Stock Options is also something to look at and consider.
• Insulating CEOs from Broad Market Swings is a method to keep the CEO motivated and working hard.
• However, it questions whether CEO's benefit from laying off workers.
• In addition, it tries to break down and understand why CEO's are paid so much.

Performance Evaluation

• Begins with a tale of two firms and how they are different in their practices.
• Looks at the supervisor's problem and how to help.
• The amount of rating categories is broken down as well.
• The worker's problem also needs to be considered
• Forced rating distributions are looked at.

Adverse Selection

• This section goes over how to best hire workers.
• An adverse selection in hiring airport security screeners example is shown.
• How to know when adverse selection will occur is important to know.
• If baseball teams can identify high-productivity players.
• Probationary contracts
• Adverse Selection in Other Areas of Economics are explored.
• Used cars is one real world application.
• Car repairs
• Health insurance as well.

Signaling

• Getting an Education is crucial to helping show employers you're fit for a job.
• Discounting the future
• Education as a Signal of Quality
• Looks at how signaling and equilibrium go hand and hand with one another.
• Determines whether education is really just a signal or not
• Other Examples of Signaling are shown.
• This is dressing for success.
• Also licensing in certain industries.
• Celebrity endorsements of charities.
• Deductibles in insurance.
• Warranties.
• Signals in nature.

Search

• Searching for a desirable profession.
• Starts by looking at Benefits and Costs of Search
• Shows the costs and benefits of searching for a job.
• Then it evaluates and understands Optimal Search strategies.
• Important features of the optimal search rule.
• Do people use the optimal search strategy?
• Determinants of the Amount of Search
• Job Search is a fundamental.
• Searching for a first job for those entering the workforce for the first time.
• For workers who are already employed, but searching for a new job.
• And searching for a job while collecting unemployment benefits.

Bargaining

• Exploring how workers and companies negotiate.
• The Goal of Bargaining is to better understand negotiations.
• Sequential Bargaining is shown.
• Impatience, Uncertainty, and Risk Aversion are three concepts to understand.
• All three of these look at impatiences.
• Uncertainty.
• Risk Aversion.
• The Nash Approach to Bargaining is another tool to utilize.

Training

• Looks at how best to train employees in certain segments.
• Training in Professional Sports
• Training and Human Capital
• Bargaining and the Value of Training
• Bargaining is essential to understand.
• Analyzes the conditions for training to occur.
• How to Make Training Worthwhile for the Firm.
• By Reducing the portability of skills.
• Training and the Incentives to Remain with a Firm.

Benefits

• Looks at benefits and how they incentivize and help workers.
• The Issue of Child Care for working parents.
• The benefits are analyzed through Preferences over Benefits and Pay.
• It's important to see The most-preferred package vs. the one offered by the firm.
• Cost Advantages for the Firm are looked at.
• The sources of cost advantages are broken down.
• The Problems Faced by Small Firms is relevant as well.

Preface

• Personnel Economics focuses on incentives and information in the workplace.
• It covers principal-agent theory.
• Addresses moral hazard in terms of imperfectly observed actions and privately-known types.
• Touches on adverse selection and signaling.
• It discusses repeated games within the employment relationship.
• Compensation schemes motivate employees.
• It looks at motivating workers when their actions are imperfectly monitored by supervisors.
• Motivating workers with varying productivity levels, unknown to the supervisor.
• Hiring high-productivity workers while avoiding low-productivity ones.
• Efficiency wages as a motivational tool.
• It explores the employment relationship from both the employer’s and the employee’s perspectives.
• Students learn how employers motivate them and issues related to job searches.
• Topics covered are not extensively covered in other undergraduate curricula.
• Labor economics texts typically have limited coverage of how compensation affects productivity.
• The book is organized around paying and hiring employees.
• Marginal analysis correctly identifies the global optimum in some cases.
• In other cases, it does not, requiring additional analysis.
• A general rule states that if the marginal benefit curve crosses the marginal cost curve only once, and from above, marginal analysis identifies the global optimum.
• If the marginal benefit curve ever crosses the marginal cost curve from below, it is necessary to look at the benefit and cost curves to find the global optimum.

General Lessons for Optimization

• If the question begins with “How much,” the answer involves marginal analysis.
• Marginal analysis identifies the local optimum.
• If marginal benefit crosses marginal cost only once and from above, marginal analysis identifies a global optimum.
• If marginal benefit ever crosses marginal cost from below, marginal analysis may not identify the global optimum.

Compensation and Motivation

• Getting paid is great because it provides one with money to spend on things that the worker likes.
• Firms must pay workers to perform tasks that they would not otherwise perform.
• Firms use a wide variety of compensation schemes to induce their workers to perform.
• Some may pay a fixed amount per unit of time, such as a monthly salary or an hourly wage, while others pay a salary plus a bonus, or some amount per unit of output, or some amount per dollar of revenue produced, such as a commission.
• Some firms only pay workers if they reach some quota or other output standard.
• The firm's compensation scheme motivates workers to perform tasks they do not enjoy.

Worker Effort and Efficiency

• The employee has only one task and must decide how much effort to devote to that task.
• The task results in output for the firm, which it can then sell at the going market price.
• Exerting effort on the task is unpleasant for the worker, which we interpret as being costly.
• Tree planters in British Columbia were compared under two different pay systems in a study.
• In one system the planters were paid by the hour, and in the other they were paid by the number of seedlings planted.
• The piece rate system induced the average worker to plant about 173 more trees per day than the salary system did, an increase of 23%.
• The piece rate system induced workers to work more quickly also induced them to take less care in planting the trees, and only about 109 of the 173 extra trees were planted well.
• In British Columbia, there has recently been a move to require that tree-planters be paid a fixed wage rather than a piece rate.
• Tree planting firms have resisted this move.

Quotas

• In a quota system, a worker must produce a certain amount before they get any money.
• And that individual will get additional money for producing more than the required minimum.
• So, a quota system is similar to a piece rate system for high amounts of effort.
• In order to get the efficient amount of effort, the firm should set a piece rate between $220 (to guarantee that the worker exerts 6 units of effort) and $240 (so that the firm does not spend more than marginal net revenue on the 6th unit of output).
• The worker is paid nothing for the first five units of output and $230 per unit for every unit beyond the fifth.
• The quota is 6 units, and the payment for meeting the quota is the same as the payment for additional units, $230.
• It is shown if, instead, the worker chooses not to exert any effort at all, their income and effort cost are both zero, for a net benefit of $0.