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ECON 308: Employment Decisions

ECON 308: Employment Decisions. Chapter 14 Attracting and retaining qualified employees Week 13: April 19 , 2010. Attracting & Retaining Employees. Principles: Maximum Value: Marginal Revenue Product (willing to pay)

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ECON 308: Employment Decisions

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  1. ECON 308: Employment Decisions Chapter 14 Attracting and retaining qualified employees Week 13: April 19 , 2010

  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 • $20-300 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-TermEmployee 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 RevenueProduct 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.

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