Attracting & Retaining Employees

1. Attracting & Retaining Employees • Principles: • People won’t come to your firm until you make them at least as well of as the could be elsewhere • 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

2. Chapter Organization • No-frills Competitive Labor Market • Some complications • Human Capital • Compensating Differentials • Costly Information • Internal Labor Markets • The Salary-Fringe Benefit Mix This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

3. 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

4. Basic Competitive Model Wage in $ Market Wage Rate Marginal Revenue Product of labor E E* Number of Employees This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

5. Human Capital • Terminology • Human Capital • Investment in Human Capital • “rate of return” on Human Capital • Types of Human Capital • General • Specific This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

6. Compensating Differentials • Consider 2 jobs • Job X pays $8/hour in clean, safe working conditions • Job Y pays $8/hour in a dirty, noisy factory • Is this an equilibrium wage? This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

7. 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. This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

8. 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

9. Costly Information • 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

10. 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

11. Internal Labor Markets • Hire at entry level, promote from within • 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

12. Tradeoffs in Long-TermEmployee Agreements • Advantages 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

13. Pay in Internal Labor Markets Compensation Salary Marginal RevenueProduct of Labor Tenure with the firm This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

14. 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 • Much time may be spent lobbying managers for promotions This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

15. 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 This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

16. Fringe Benefits • Payroll taxes • Changes tradeoff between salary and fringe benefits • 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. This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

17. Practice Questions 14.2 In the basic competitive model, why do employees pay for general training and firms pay for specific training? This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

18. Practice Questions 14.3 Why do firms form internal labor markets? 14.4 Evaluate the following statement: “Firms are free to set salaries in any manner they want in an internal labor market.” This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

19. Practice Questions 14-12. The university of Medford pays the full tuition for the children of faculty members at any university in the world. Recently, this policy has received bad publicity. The argument has been made that people in other occupations have to pay the tuition costs for their children and so should college professors. According to this argument, it is not fair to have these relatively well paid people get subsidized in this manner. The board of trustees of the University of Medford has been asked to reconsider this policy. Provide an economic argument to explain why the board of trustees might want to continue this policy. This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

20. Practice Questions 14-9. A recent study found that CEOs in Europe are paid less than CEO’s in the U.S. even after controlling for a firm’s size and industry. Does this imply that U.S. executives are overpaid? Explain. This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

21. Practice Questions Statement 1: “People prefer to get paid money, rather than fringe benefits, since they can choose how they spend it. As a general rule, if the firm can’t get a better price for the benefit than the employees can, a profit-maximizing firm will pay employees money rather than benefits.” Statement 2: “Since employees have different tastes in fringe benefits, it is generally profitable to give employees lots of choice among different benefits packages.” a. Both statements are true b. Both statements are false c. Statement 1 is true, but 2 is false d. Statement 2 is true, but 1 is false This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.

22. Practice Questions Which of the following is not an advantage of internal labor markets? a. Workers tend to accumulate more firm-specific human capital b. Managers tend to learn more about employee attributes c. Motivation of workers is often better d. More types of skill are available to hire when filling high level jobs This slideshow was written by Ken Chapman, but is substantially based on concepts from Managerial Economics and Organizational Architecture by Brickley Zimmerman & Smith, McGraw-Hill, 2004.