Human Resources I (2014)Apunte Inglés
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Human Resources I 1
TOPIC 1: Human Resources challenges and
The challenges of human resources are:
External environment: It changes, new media arise,
globalization, society roles, workforce diversity*,
worldwide economic crises,…In general it refers to
forces which are external to the firm but influence
organizational performance and at the same time
are largely beyond management’s control.
Organization: Performance of CEOs and General Management who take strategic decisions, organizational culture, decentralization, downsizing, outsourcing**…In general it refers to problems that arise from strategic decisions Individuals: Problems of poor performance, productivity*** or empowerment among others may arise. In general, Refer to challenges derived from problems of specific workers **Deeper: Decentralization Based on the transfer of decision-making authority (in other words, provide autonomy) from higher to lower levels in the organization Downsizing It’s a standard business practice based on the proper management of separations Outsourcing Externalize some part of the production process (also used in services) *Deeper: The case of Workforce diversity In 2009, approximately 34% of the U.S. workforce was from a minority group and in large cities, around 50% of the workforce belongs to a minority group. These trends are likely to accelerate in the future.
Is it an opportunity or a threat? It may create conflicts It could also benefit from the point of view of creativity and flexibility In any case, firms that formulate and implement HR strategies that capitalize on employee diversity Employees may face layoffs Consumer dissatisfaction can result if subcontrators are not carefully watched and evaluated Ethical HR standards among its subcontrators around the world must be established Serious image problem Consequences o o Downsizing (to manage the layoff process effectively) Changes in labor practices The case of Nike: As a strategy the Company could save costs by outsourcing all manufacturing → the money saved would be poured into marketing But as Jeff Ballinger states: Nike’s policies of competing on the basis of cost fostered and even encourage contractors to mistreat their workers in pursuit of unrealistic production quotas ***Deeper: Productivity Human Resources I 2 Carla Martinez Employee productivity is affected by ability and motivation Ability: Determined in the hiring process which selects the best individuals for the job or training programs Motivation: can be improved using rewards or with an appropriate design of the job position Sometimes business need to reduce labor costs Who should be electable for a buyout? By for example Hiring freeze, shorter workweek, job sharing, demotions, pay freeze, cut overtime pay, pay cuts,..
Self-selection: If you let workers choose the smart ones would leave since they are aware of the better alternatives they have outside the firm (Adverse selection) Or you could just offer buyouts to the chosen not-that-good workers Buyouts: a contract in which the firm commits to pay the worker a certain amount of money if the worker commits to leave the job voluntarily Strategic HR Policies: are the options that a company has available in designing its human resources system. Are normally functions of the HR department who uses many different HR programs to implement each of these strategies which are, for instance: Work flows: Based on the design of job positions.
o Efficiency (getting work done at minimum cost) vs innovation (encouraging creativity, developing new products or processes) Hiring: o Emphasizing a good fit between the applicant and the firm (when the personality of the worker matches the values of the firm) vs hiring the most knowledgeable individual regardless of interpersonal considerations (when the individual has only the needed technical skills) o Hiring new workers informally (requires a low investment) vs choosing a more formal and systematic approach to hiring (requires a higher investment) Employee separations o Use of voluntary inducements (eg. early retirement packages) to downsize a workforce vs layoffs Training o Deciding on whether to teach required skills on the job vs rely on external sources for training o Deciding whether the firm will assume the costs of training or the worker or not Compensation o Pay a fix salary vs pay for performance o Rewarding employees for the time they have spent with the firm vs rewarding for performance o Deciding whether to lead or lag the going rate Human Resources I 3 Carla Martinez There is no good or bad strategy.
It depends on: how well strategy fits with other factors if the strategies reinforce one another rather than work at cross-purposes Fit with Organizational Strategies There are two major types of corporate strategies: Evolutionary business strategy: when corporations engage in aggressive acquisitions of new business even in the case of unrelated diversification. For instance, Dupont.
Steady-state strategy: when mainly all acquisitions made by a company are industry-related. For instance, the case of Rubbermaid Regarding business units we can find several strategies as well (Porter’s): Overall cost leadership strategy which is aimed at gaining a competitive advantage through lower costs than competitors Differentiation business strategy which attempts to achieve a competitive advantage by creating a product or service that is perceived as being unique or at least different in any way from other existing products in the market TOPIC 2: Hiring First of all, let’s see an example → A Bug’s Life Flik travels from his country colony to a bug city to recruit an insect army of “bigger bugs” to protect his colony from grasshoppers. He is desperate to find help to save his colony because it’s his fault it is in danger. In the video seen in class he mistakes bugs which have just been fired from the circus for warriors.
Analysis Flik bases his decision entirely on the impression that the bugs were warriors, and did not follow up with any questions about their past experience Flik should have slowed down, and expressed his needs to the circus bugs as well as listened to their needs and qualifications Conclusion Desperation can drive the hiring process On this topic we will take a look at Setting hiring standards (in terms of quality and risk) The hiring process (which includes Recruiting, Selection and Socialization) Sources of recruitment and selection tools Human Resources I 4 Carla Martinez Setting hiring standards (based on the economic principles of hiring) When a company needs to hire a new worker, whom should the firm hire for the job? Firms take decisions choosing between the best/worst quality workers or the riskier ones (which usually provide greater returns for the firm) Quality Let's hire the best workers Let's hire the worst workers Let’s see an example: Whom should the company hire for the job? It can be unnecessarily expensive Although cheaper, they can be bad performers Productivity (sales/year) Wages (per hour) College graduates High School graduates Sales/Month $1.88M/12 = $156, 944 $1.48M/12 = $122.917 Assuming a targeted profits of $1, 000,000/month. How many workers are needed to reach it? $1M/$156,944 = 6.372 workers $1M/$122,917 = 8.136, workers Cost of (assumed) 176 hours/month 6.372*$10.25*176 = $ 11,495 College graduates $1.88M $10.25 8.136*$6.82*176 = $9,766 High school graduates $1.48M $6.82 CONCLUSION It is more profitable to hire high school graduates as long as: Which indicates the most costeffective worker We could also represent this problem with the cost-efectiveness study: Should the company then, rely on unproductive workers when facing financial problems? None of the analysis makes mention of the firm’s financial condition Choosing the wrong kind of labor will only make the financial condition worse Firm should always try to hire the most productive in this situation Example: Financial condition of the firm is not going to change the analysis.
University grads: $30.000, salary: $9.49 HS grads: $20.000, salary: $7.05 Assume too that the firm is earning profits of $1M See the increase in profitability University grads Q= $30,000 Costs=9.49*8(hours/day)*22(days/month)*12(months/y ear) C = $20.043 Benefit = 30.000 - 20.043 = $9.957, which increases profits to 1.009.957 HS grads Q= $20,000 Costs=7.05*8(hours/day)*22(days/month)*12(months/y ear) C = $14.890 Benefit = 20.000 - 14.890 = $5.5110, which increases profits to 1.005.110 Human Resources I 5 Carla Martinez Applications: Foreign competition: It is often argued that countries with low labor costs drive companies in countries with high labor costs out of business. Is that accurate? Country Annual salary GDP per worker Cost per $ of GDP Japan $33,373 $78,065 0,430 Argentina $9,973 $22,399 0,445 Cost of worker per $ of GDP ends up being more or less equal! Risk Let’s see an example: Whom should the company hire for the job? Jaume → Has no risk Ana → has no experience but good recommendations of her teachers, so we don’t know if she will be a good worker or not Further assumptions: Jaume Ana $200,000/year $500,000/year -$100,000/year cost of each employee (wage) is $ 100,000/year both workers are age 30 and work until 65 the probation period of Ana lasts for 1 year The expected value of Anais $ 6.9M and the expected value of Jaume is $ 3.5M Ana is so much more valuable than Jaume *It takes one year to know the results of Ana Benefits Jaume: $200,000-$100,000 * 35 = $3.5M Ana = $6.9M o $500,000-$100,000 * 35 = $14M(0.5) o -$100,000-100,000 * 1 = -200,000(0.5) Human Resources I 6 Carla Martinez Sensitivity Analysis Productivity: The more the potential there is for an employee to destroy value, the less likely s to be optimal to take a chance on a risky worker Length of employment: The value of a risky hire will usually be larger the younger the new hire Length of evaluation: If the evaluation takes many years there is no value in hiring the risky worker The hiring process Once a firm has decided which types of workers it would like to hire, it must hire those ones: How the firm can attract the right types of applicants? RECRUITMENT, the process of generating a pool of qualified candidates for a particular job How can the firm weed out undesirable applicants? SELECTION, the process of making a “hire” or “no hire” decision SOCIALIZATION: orients new employees to the organization and to the units in which they will be working (specific tasks) Recruitment Self-selection through: Contingent contracts: compensation is structured in a way that is attractive to highly skilled workers o Pay-for-performance: Workers are compensated on the basis of performance (W = b.PM, where b=piece rate and PM=the performance measure) Hourly performance Hourly wage-other option Productive 6 $20 Unproductive 4 $16 What is the piece rate that will induce productive workers to apply and unproductive workers to stay away? bx6>20 Which account for the conditions to solve this question.
bx4<16 Therefore, 3.3 < b < 4 should be set in order to attract good applicants and deter bad workers High salary: Cream of the crop Problems with self-selection Pay for performance Not necesarily true that workers know their productivity (symmetric ignorance) High salary Symmetric ignorance Asymmetric information Human Resources I 7 Carla Martinez Let’s see an example: Value for the firm Opportunity cost Probability High productivity $3000 $2500 1/3 Low productivity $2000 $1000 2/3 Perfect Information Both the firm and the worker know the productivity of the worker Salary for the productive worker [$3000,$2500]. If workers have a lot of bargaining power (when demand is larger than supply in the labor market), the salary will be $3000 Salary for the low productivity worker [$2000,$1000]. If workers have a lot of bargaining, the salary will be $2000 Symmetric ignorance Neither the firm, nor the worker know the productivity of the worker, so the firm is going to offer an average.
Wmax = [3000 x 1/3 + 2000 x 2/3] = $2333,33 Wmin = [2500 x 1/3 + 1000 x 2/3] = $1500 The wage would lie within the range [$2333,33, $1500]. If workers have a lot of bargaining, the salary will be $2333,33 Asymmetric information Firm doesn’t have information about worker’s productivity but the worker itself does. If the firm offered an average ($2333,33), it would not be enough for good workers (whose opportunity cost is $2500) so it will only attract the low productive ones and at the same time, it would pay them too much since their opportunity cost is $1000 The firm can foresee this situation and will ultimately set lower wages. Only low productive workers would be attracted at $2000 Both self-selection mechanisms (pay for performance and high wages) have problems. A firm may solve them using screening tools. Recruiting is also considered a way of self-selection so the firm needs to screen again.
Screening is then useful to determine a worker’s productivity. It can be estimated through: Credentials (education, experience), probation periods, psychological profiling, tests, interviews, etc.
Should firms invest a lot in screening? Hiring new workers informally (low investment) vs choosing a more formal and systematic approach to hiring (high investment) → It is costly if done in a formal way but it offers high benefits for the firm An example: Is screening profitable? Here we have some investment banking job applicants which differ dramatically in their abilities: Type A B C Percent Annual Productivity (Per 10 workers) 10% -$100K 20% 30% 0 $50K D E 30% $100K 10% $200K Salary is $40,000 per employee/year Costs of screening per worker $1,000 Human Resources I 8 Carla Martinez Without screening Performance: 1(-100) + 2(0) + 3(50) + 3(100) + 1(200) = $550,000 With Screening We can eliminate A and B since they incur no benefits for the company. Then, performance: 3(50) + 3(100) + 1(200) = $650,000 Costs = $290,000 Salaries: $280,000 (7x40,000) Screening: $10,000 Profit: $360,000 Screening is a good idea! (In this case, not always) Salary (costs): $400,000 Profit: $150,000 What determines profitability of screening? 1. Cost of Screening 2. Number of bad workers in society 3. Accuracy of the screening tool More formally: Without screening Benefits With screening Benefits ΔBenefits ( ) +( )( ) , where p: probability that applicant is productive )( )( ) ( ) +( probability that the correct decision is made ( )( )-( ) ( ) , where s: cost of screening and q: Then: >0 Better screening quality, higher profits of screening <0 Higher cost, lower profit of screening <0 More people doing good, lower benefits of screening (you don’t need the tool that much) Types of screening: Probation periods Credentials Signaling Interviews Tests Signalling Assumptions: o Students learn nothing in school o More talented students find it easier to learn the material quickly* Result: Signal their talents to the labor market by investing in more education than less talented students Human Resources I 9 Carla Martinez Separating and pooling equilibria Quicks (α) Slows (1-α) ̅ ( ).
*Cost of obtaining the signal (credential on education) ( ) The quicks would like to distinguish themselves from the slows ( ) The slows would like to be confused with quicks So the conditions that have to be satisfied are: ̅ Hiring in practice Some sources of recruiting are Current employees Referrals from current employees Former employees Print advertising Internet advertising and career sites Employment agencies Temporary workers College recruiting Drug tests Reference checks Background checks Handwritin analysis Credentials Probation Selection techniques Letters of recommendation Application forms Ability tests Personality tests Honesty tests Interviews Assessment centers Work sample tests → asks applicants to perform the exact same tasks that they will be performing on the job Honesty tests → designed to identify job applicants who are likely to engage in theft and other undesirable behavior Are not highly related to job performance because most are highly positive Still should be taken into account Focus on the content rather than on their positivity Interviews are the most common selection tool but still are criticized: Sometimes interviewers do not agree with one another on candidate assessment Human judgment limitations and interviewer biases Human Resources I 10 Carla Martinez Traditional interviews are conducted in such a way that the interview experience is very different from interviewee to interviewee A structured interview applies a series of job related questions with predetermined answers consistently across all interviews for a particular job Situational questions try to elicit from candidates how they would respond to particular work situations Job knowledge questions assess whether candidates have the basic knowledge needed to perform a job Workers requirements questions assess candidates’ willingness to perform under prevailing job conditions Why does the traditional interview remain popular? Still, the unstructured interview may be a valid predictor of the degree to which a candidate will fit with the organization Assessment centers are sets of simulated tasks or exercises that candidates are asked to perform. Observers rate performance on these simulations and make inferences regarding each candidate’s skills and abilities. Evaluate candidates in four areas: organizing, planning, decision-making and leadership Are a valid predictor of managerial job performance Expensive TOPIC 3: Investments in skills There are several types or ways to invest on skills: Education, on the job training or training in practice. Up until know we had assumed that workers had fixed talent and we analyzed the implications of sorting the workforce.
But, in reality, not only workers learn over time (formal education and on the job) but also it increases their productivity .
Investment on skills can be modeled just like any other kind of investment. They are made if the present value of the cash flow (incremental productivity/earnings) exceeds the present value of the cost of investment (tuition, opportunity costs,…) Mathematical Periods: 1, 2, …, T Example Costs (borne up front and Directs (tuition, text Student drop out now: Ht do not need to be books): C0 Student continues on in school: Kt discounted) Interest rate r per year Opportunity costs: F0 Present value of the Investments in education T K H t return on education t t 1 1 r t T The decision rule: C0 F0 t 1 Kt H t 1 r t Human Resources I 11 Carla Martinez If this expression holds finishing college is a good investment For early years of schooling, the Eventually, the It pays for everybody to returns to schooling exceed the reverse must be invest in education but there costs true is an optimal stopping point Much to be learned Forgone earnings are low In 1970, college graduates earned about 50% more than high school graduates.
By 2006 they earned more than twice as much In the United States, Asia or Europe the rate of return on higher education is usually estimated to be about 11% per year Investments in “on the job” training Increase workers skills and raise productivity, just like education. It also has some costs, such as: compensation for trainers, books, etc (direct), or lower productivity (indirect cost). It’s easy to see that those kind of investment have similar implications to our discussion of investments in education But, there are two types of human capital General human capital Firm-specific human capital •Equally valuable inside and outside the firm (MBA, English) •Has not value at all ouside the firm (operate an unusual machine, corporate culture) Then, Who should pay for training? Education On the job training General Firm-specific If skills are completely general Workers productivity rises only at human capital, the worker should her current firm pay for 100% of the investment and receive 100% of the benefits.
Is this a good investment for employers? A firm pays for an student considering finishing her college degree → Market value will rise → The firm will have to rise her salary → It is highly unlikely to capture most of the benefits from the schooling investment → The employee will enjoy the benefits from schooling The typical solution is for individuals to The typical solution is for No matter who makes the pay for schooling.
individuals to pay for general “on investment, the other side has an the job” training.
incentive to break its promise Why? Numerical Example Two periods No training: Workers will have a productivity H = $10,000 (training and post training) Training No First period: discounting o Invest Co + Fo = $5,000 o Net productivity $5,000 Second period: o The worker’s productivity rises to $15,200 everywhere Human Resources I 12 Carla Martinez Terms Co → Direct Costs Investment Fo → Fixed Costs human capital K → productivity after investment H → productivity in If no training, productivity in both periods is going to be $10,000 = H. If training in the first period there’s an investment of $5,000 = Co + Fo. Then, the net productivity is $10,000 - $5,000= $5,000, then why investment? Because of the expected raise in productivity in the next period. Post training period H=$15,200 1. What if the worker pays for investment? Workers: suffer a lost in the first period ($5,000) and earns a profit ($5,200) in the second period Firm: earns no profit or loss in either period And What might the firm do? As $15,200 > $10,000, the firm may be tempted to renegotiate after the investment is made to capture some of the profits of the worker’s investment (Holdup problem), and therefore, the worker is not going to invest.
2. What if the firm pays for investment? Firm: pay for investment ($5000) and earn the reward ($5,200) Workers: receive $10,000 in each period And, What might the worker do? Since $15,200 > $10,000, once the investment is made the worker may be tempted to renegotiate. For instance, the worker will ask for an increase in salary in order to capture some of the profits of the firm’s investment (Holdup problem). As a result, the firm is not going to invest.
CONCLUSION: No matter who makes the investment, the other side has an incentive to break its promise and try to renegotiate after the training has been paid for.
How can this problem be solved? Spliting the costs and returns of the investment W1 in the first period W2 in the second period Since both would have something to lose if the relationship were broken, both have some incentive to avoid renegotiation Human Resources I 13 Carla Martinez Human capital is partly general and partly firm specific Another example: Enterprise software that does tax optimization. The worker’s outside value is lower than his inside value after the training, even though the labor market does value the training.
The implications are: General: Neither the firm nor the worker care about turnover. Largely hired through spot-market type transactions.
Specific: Both lose if the worker leaves.
Training in practice Challenges in Training Does training provide the solution? Not all performance problems call for training, because they can have several causes, for example: unclear or conflicting requests, morale problems, and poor quality materials which cannot be improved through training Is training a good investment? Are training goals clear and realistic? Training is expensive, however, it To be successful, a training program can pay off in more capable and must have clearly stated and realistic loyal workers → A study of more goals than 5000 organizations in 26 countries found that the greater the investment in employee training, the more profitable the firm (Hansson 2006). There are also tactics from training professionals to reduce costs like: Look inside, Do you need it?, Give training a strategic alignment, Consider e-learning.
Implementation of training Presentation options include: Slides and Videotapes, Teletraining (Trainees are dispersed and it may be expensive and difficult to schedule), Computers (which eliminate travel and lodging costs), Simulations or Virtual Reality.
This is the case of devices or situations that replicate job demands at an off-the job site. Are normally used when the equipment used on the job is expensive and/or the cost of wrong decision is high It is a computer-generated virtual environment that replicates the entire real-life rather than just several aspects of it, as do simulations. Aim is to rehearsal and practice, working from a remote location, visualizing objects and process that are not usually accessible and when there is high potential for damage to equipment or danger to individuals Human Resources I 14 Carla Martinez The different types of training are: Skills Training, Retraining, Creativity Training, Literacy Training, Diversity Training, Crisis Training, Ethics Training, Customer Service Training, Cross-Functional Training and Team Training.
Cross-Functional Training Team Training •Teaches employees to perform operations in other areas of their assigned work •It is valuable for firms as current workers are more versatile and the rest of employees do the same thing •Teaches a group to function as a team •Teaches how to behave towards one another properly and resolve conflicts TOPIC 4: Managing Turnover Quits → Can happen at any time Voluntary Retirements → happen at the end of an employee’s career Discharges → emerge from a poor fit between the employee and the organization (poor performance or unacceptable behavior) Categories of Employee Separations Involuntary Layoffs when management decides to terminate its relationship with an employee → Are due to an economic necessity (are means for an organization to cut costs) Layoffs have a negative impact on the organization o They can affect the morale of the organization’s remaining employees, who may fear losing their jobs in the future o The investment community may interpret a layoff as a signal that the company is having serious problems o Can hurt a company’s standing as a good place to work and make it difficult to recruit highly skilled employees who can chose among numerous employers Some alternatives to save costs are Buyouts or early retirement. Some other employment policies to do so may be: Attrition: not filling job vacancies that are created by turnover Hiring freeze: not hiring any new employees into the company Voluntary (unpaid) time off (VTO) Shorter workweek: 35 hours rather than 40 hours Therefore, it’s important to consider other alternatives before finally deciding to implement a layoff The company could also make Changes in job design Job sharing: e.g. reconfigure one job into two part time jobs Demotions: highly paid workers may be demoted to lower-paying jobs Human Resources I 15 Carla Martinez To reduce costs regarding Pay and benefit policies, the company could: Pay freeze: no wages or salaries are increased Pay cut Cut overtime pay Pay-for-performance Unfortunately, sometimes firms must downsize by firing large groups of employees. Who to target for layoffs? The most expensive workers vs those with the worst performance.
→ You should fire the least cost-effective workers. In other words, separate the worst performers for every category of salary, and select those employees from which the firm is losing money relative to other employees.
The problem is then, finding the right measures of performance → if you don’t use the right criteria, you may end up going to court and losing (as workers may sue you if they feel unfairly laid off) Specific human capital theory states that both the worker and the firm are likely to be sharing the costs and benefits of training investments and its main implication is that when firm-specific human capital is important, the firm maximizes its profits by laying off from both ends of the age distribution (youngest and oldest) Numerical case Kt: productivity profile of the worker along the career Wt: wage profile of the worker during its career At: best alternative outside the firm (op. cost of worker outside the firm) T: optimal point of retirement B < 1: Parameter that represents an economic crisis Pt: rent or profits generated by a worker At the begining: Wo > Ko. Therefore, at any point after t = 0, the present value of the productivity profile Kt is higher than the present value of the wage profile Wt.
Moreover, we will assume that the labor market is competitive: PV(W) = PV(K), why? If PV (W) > PV (K) the company would lose money If PV (W) < PV (K) the company would have problems retaining employees This difference (PV(Kt) – PV(Wt)) is the return that is earned by the firm. Though the present values of wages and productivity are equal at the time when the worker is hired (t = 0), they are not thereafter. As we move to the right on the graph PV(W) is lower than PV(K).
Human Resources I 16 Carla Martinez Pt= PV(Kt)-PV(Wt) t0 = 0 Implies no profits What is the form of Pt? or the firm (Pt=0) t + 0 = Pt > 0 implies firm makes profits (Pt>0) t - 0 = Pt < 0 implies firm loses Employee that is about to retire: Although its pay is below productivity, there is little remaining profit for the firm to earn since there is little time left in his career Employee that is very new to the firm: little training investment has yet been made Best target for layoffs → Young workers because are typically not legally protected and they have invested little in firm-specific skills. Furthermore, in general, the firm earns the greatest profits on workers who have completed their training and have both high productivity and relatively long remaining careers. Besides, older workers are protected by anti-discriminatory regulations in most countries and are at the time enjoying the returns on their investment as was promised to them.
When the worker is old, close to retirement, the firm has recovered the whole or almost all investment in firmspecific knowledge of this worker. So in reality it would be optimal to fire or the youngest workers or the ones who are about to retire.
Another case: Imagine that productivity falls due to an economic crisis. On the graph, this is shown as a drop in Kt to BKt (B<1) and therefore, as a downward shift in the present value Pt to P’t → the only workers that would be profitably employed in this circumstance would be workers with middle ages.
In the case layoffs of young workers are not enough, voluntary separations (buyout contracts) to old workers should be offered. In exchange for some compensation, the employee agrees to end employment with the firm.
Who should be eligible for a buyout? The adverse selection problem At any wage category some employees are more productive than others. The most productive workers are more likely to have better alternative employment elsewhere. The company would then loose from offering them the buyout. Then, What to do? The best performing employees might not be offered buyouts.
Furthermore, out of the most senior workers, those close to retirement have little to lose from leaving the firm, since they have already earned most of the return on their investment in skills, so they require only small buyouts packages.
Implementation Window Plan: offering a small period during which the buyout is available. Why? the lower the productivity of the worker, the more anxious is the firm to be rid of him, and the higher the buyout offer the firm is willing to make but if a buyout is anticipated, a worker has incentives to reduce productivity.
Job placement (outplacement) services: Saves costs, lowering the buyout price required by improving the possibility for workers to find outside work Layoff in practice Notifying employees: The number of day’s advance notice to employees who will be layoff varies according to each country o Laid-off employees should first learn of their fate from their supervisor in a face-to-face private discussion, which has to be brief and to the point. The manager should express appreciation for what the employee has contributed and explain how much severance pay and what benefits will be Human Resources I 17 Carla Martinez provided and for how long. It’s important to avoid telling workers during their vacation or right before a weekend Developing layoff criteria: The criteria for dismissal must be clear so managers responsible for determining who will be laid off can make consistent decisions. There are two main criteria: o Performance: Allows the company to retain its top performers in every work unit and eliminate its weakest performers. It’s important to develop a valid performance apraisal system otherwise the company may be exposed to wrongful discharge litigation if the employee can prove that management discriminated or acted arbitrarily in judging performance. Because of legal risks and unions, many companies avoid using performance as a basis for layoff.
o Seniority: which takes as a basis the amount of time that the employee has been within the firm, “last in, first out” (LIFO). It’s useful because is easily applied (managers simply examine all employees’ dates of hire to determine the seniority) and many employees see the seniority system as fair because managers cannot play favorites. At the same time it involves some risk since the firm may lose some top performers Maintaining security: In some situations layoffs may threaten company property. Ex-employees could be rushed out of the building, escorted by army guards, and their personal belongings delivered to them later in boxes. Although it may seem harsh, sometimes it may be necessary.
It’s also important to take into account the Reassuring survivors of the layoff. Survivor’s productivity may drop as a result of the layoff.
Some companies also Provide Outplacement, which is a HR program created to help separated employees deal with the emotional stress of job loss and provide assistance in finding a new job and therefore provide Emotional support.
It could also include Job-search assistance by teaching the skills they need to find a new job or providing administrative support.
Besides layoffs we also stated that the Quit option was available. Those practices depend on the employee’s level of disatisfaction with the job and are expensive Recruitment costs include advertising the job vacancy, using a professional recruiter to travel to various locations (e.g. college campuses) or employing a search firm (executive positions or technologicaly complex) Selection costs includes the costs asociated with selecting and placing a new employee in a job o Interviews, testing the employee, and conducting reference checks, etc o Relocation costs (moving employes personal property, travel and sometimes housing costs, e.g.
selling the old house and buying a new house) Training costs: Most new employees need some training to do their job. Cost of instruction, books, material but also some productivity is lost.
Separation costs: Include the pay itself and the exit interview costs (to find the reasons why the employee is leaving or to provide counceling and/or assistence in finding a new job) Loss of talent: It can be avoided by retention strategies such as: o Increase compensation: which may be expensive in terms of more salary, but it can be also done by Internal equity offering o Stocks, options, bonus o Offering becoming a Partner o Benefits (flexible working hours, training) o Job enrichment o Early promotions Human Resources I 18 Carla Martinez TOPIC 5: Compensation What is total compensation? It’s the sum of total quantifiable rewards received for an employee’s labor. It includes: Total compensation Base compensation Pay incentives Benefits Base compensation: The fixed pay an employee receives on a regular basis (e.g. weekly, monthly or hourly wage) Pay incentives (pay-for-performance): Programs designed to reward employees for good performance (e.g. bonuses or profit sharing) Indirect compensation (benefits): E.g. health insurance, tuition reimbursement, perquisites or perks (usually for upper level managers) Base compensation (fixed salary): job based approach. It’s the most traditional type of compensation. It appears usually in well-defined jobs such as secretary or bookkeeper. It has three goals: Internal equity (the distributive Justice model): holds that employees exchange their contributions or inputs to the firm (skills, effort) for compensation. Then, employees are comparing (1) what they bring to the firm and what they receive in return and (2) this input/compensation ratio with that of other employees within the same firm. When the ratio of their imputs and outputs is equivalent to that of other employees, the worker assumes he’s fairly paid.
External equity (labor market model): Wage rate determined by supply and demand. External equity is achieved when the firm pays its employees the “going rate” for the type of work they do.
Individual equity What do companies do to achieve them? Internal equity: Carry out a process of job evaluation: five steps intended to provide a rational, orderly, and systematic judgement of how important each job is to the firm 1. Job Analysis: Information is gathered about the tasks, duties and responsibilities of all jobs being evaluated through interviews, observation, and questionnaires.
2. Write job descriptions: The main elements of a job description are: Identification information, Job summary, Job tasks, duties and responsibilities and Job specifications (Licenses, necessary years and type of prior work experience, level and type of education) 3. Rate worth of all Jobs: Normally done by a three- to seven- person committee that may include supervisors, managers, HR department staff, and outside consultants 4. Create a Job Hierarchy: List jobs in terms of their relative assessed value 5. Classify Jobs by Grade Levels for simplicity External equity: Firms conduct a market survey to determine the pay ranges for each grade level. Cunsulting firms conduct literally hundreds of such surveys each year for (almost) every type of job and geographic area Individual equity: Assign each employee a pay rate within the range established for his or her job.
Companies frequently use previous experience, seniority and performance appraisal ratings to determine how much an employee is to be paid within the stipulated range for his or her job.
Human Resources I 19 Carla Martinez Fixed salary versus pay-for-performance. It’s the principal-agent model in which effort is difficult to monitor and incentives link compensation to a measure of performance What does the employee’s incentive depend on? Should the employee work a little harder or not? It depends on Marginal benefits compared to marginal costs.
( ) ( ) ̅ From the formula we can extract that: Anything that increases the marginal benefit will increase the employee’s effort.
How does the performance measure (PM) vary with effort? if it reflects the employee’s effort well, it will improve incentives How does pay vary with measured performance? If it does so strongly, incentives will be stronger Performance evaluation is the most difficult part of the incentives scheme, as it depends on groups, luck and is difficult to quantify. Still, there are some ways to evaluate performance: Outputs vs Inputs Output o Broad: Stock price (executives in publicly traded firms) o Narrow: Quantity a worker produces (manufacturing setting) Quality (manufacturing setting) Revenue, costs or profits (plant manager) Inputs o Number of tasks accomplished o Behavior (comes to meetings on time) Quantitative vs Qualitative Quantitative o Advantages Tie to compensation more easily Are objective o Limitations Risk vs distortion Manipulation Qualitative Human Resources I 20 Carla Martinez o o Advantages Improve quantitative performance measures (Filter uncontrollable, reduce distortions, reduce manipulation) Limitations The most painful job for managers (Leniency bias) Employees dislike subjectives evaluations too (Supervisors’ personal bias) Pay-for-performance compensation has two human resource objectives: Self-selection and Motivation Self-selection (Beneficial for the firm) PM = PM(A, H) 𝟎 𝟎 Motivation: Aims at increasing employee effort, therefore, How should the firm vary pay with the performance evaluation? Pay = a + b.PM If the employee works a little bit harder, there’s a small increase the performance measure.
The reward will be B, which is the same for both plans.
How strong should (the intensity of) incentives be? Numerical example We have a salesperson selling personal computers with a fixed cost: of $1.000.000 and a marginal cost of $9,000.
The price at which each computer is sold is $10.000, so marginal profit is $1.000. We also make some assumptions Human Resources I 21 Carla Martinez like: the compensation of the worker represents a % of revenue (PM) and that there’s no risk because performance is perfectly measured, mathematically: No risk → , PM is capturing the level of effort very well.
Computers sold Total disutility of effort Marginal disutility of effort 1 2 … 20 23 25 26 $20 $80 … $8000 $10 058 $12 500 $13 520 $20 $60 … $780 $900 $980 $1 020 1st column = computers sold = PM, as no risk: PM = e 2nd column = cost of effort 3rd column = marginal disutility of effort = marginal cost of effort = ( ) ( ) We assume for the worker to maximize its benefits, marginal revenue = marginal costs (production and disutility of effort).
What is the optimal level of output? The idea is to try to equalize MR = MC production + MC of effort, therefore: 10,000 = 9,000 + x. The solution of the table that makes our result closer to 10,000 is taking 980 as a marginal disutility of effort, and therefore, producing 25 computers What is the optimal comission (b*)? B*MR=MC If we know that, b*10,000=980, b≈10% If there’s no risk: b=100% = -a → negative salary → the worker has to pay to the firm, therefore Pay = -a +100%PM The example of the taxi drivers The example of the waiting staff Pay = -350 (which the driver pays to the firm) + Some waiters accept a w < minimum legal wage, so they $3.2*(miles) – Gasoline have a negative salary What is the effect of risk on optimal (intensity of) incentives? It is virtually impossible to develop a performance measure that is error free and moreover, individuals tend to be risk averse, so that risk generates a psychological cost for the workers. So if we update our model, the total cost for the employee would end up being: R = captures the degree of risk aversion of the worker captures the degree of risk of the PM Pay = a + and → Pay = a + ( ) → Pay = a + ( ) The less accurate the performance measure, the greater the risk premium that must be Risk Premium paid Assumptions: ε (which is a random variable) ~ (0, ) and R=0 So, the conclusion is: when there’s no risk, b=100%, but when there’s risk, b<100% Human Resources I 22 Carla Martinez Then the maximization problem of the worker becomes: ( ( ) ) ( ) → FOC: C’ (e) = b → And the maximization problem for the firm is: ( ) ICC C’ (e) and PC Pay a e* C(e*) which by FOC becomes: ( ( )) = 0 and b = 1.
In the case R>0, risk premium = 0 and ε ~ (0, ) The maximization problem for the worker: ( ) FOC: ; ( ) ; b= C’(e), which is the marginal cost of effort. So, if you want your worker to increase his cost of effort (its effort in general), you have to compensate by increasing b.
Max problem for the firm: Max Be, where Be = Revenues – Costs R = Price * PM and if we assume that Price = 1 and PM = , where ε ~ (0, ) Then R = 1*(e) → R=e and therefore: ( ) ( ) ( ) ( ) ( ( ) ) ( ( )) ( ) 1-b=0 B=1 = 100% =( ) Which proves basically what we said before that, when R=0, b=100 Human Resources I 23 Carla Martinez Salaries versus benefits Benefits play an important role regarding compensation. Some examples of benefits offered by companies may be: Health insurance, paid time off, tuition reimbursement, on-site child care, subsidized meals, concierge services, perks,…but, How much should a firm pay in wages and how much in benefits? Numerical example! To solve this case we have some assumptions: 1. A given health plan costs $3, 500 per year 2. The firm must offer the plan to all of its workers or to none at all Some important fact to take into account is that the cost of the health plan is not necessarily the value of the plan to employees. Instead, its value is defined as the amount that the individual would just be willing to pay.
How a firm can determine how much a plan is worth to its workforce? Voting: $3,500 in cash or in benefits. The firm would be indifferent since the cost for them is the same.
However; the firm could be giving something away for nothing. Why? Imagine a worker is willing to give up as much as $3,750 for the health benefit but they realize the true value of the plan and decide not to get it.
Asking the workers: they could behave strategically and understate the true value Market studies of the relation of wages to benefits For example: Suppose that we obtained a data set from a human resources consultant Firm Salary Health plan 1 2 3 4 N = 25 $59,701 $52,594 $59,193 $54, 817 … No No Yes Yes … Salary = ßo +ß1(Health plan dummy, yes or no) + λ So that, Salary = 55, 827 - 1,836(Health plan dummy) Which means: Without health plan, the typical salary is $55,827 With health plan, the typical salary is $53,991 The worker is willing to accept a cut of $1,836 for the benefit So, in conclusion: In this specific case, the workers are not willing to trade off enough wages to make the plan worthwhile (as it’s valued on $3500 and they only give a value of $1836 to it).
How can companies reduce the costs of benefits? Economies of scale o Lower the costs of insurance compared to market rates (pool risk by buying insurance to all its workforce) o Procure some goods for employees at below market rates (discount). E.g: Worker values the gym or health club at $40/month. The cost for the firm is $30. As a manager: it’s useful to buy the membership and reduce the salary of the worker by $35, but as the real cost for the company is $30, the firm is saving $5 per worker. As a worker: they value the membership at $5, but the firm is reducing its salary by $35, therefore, they are earning $5 too. This problem represents a clear case of copayment (both win).
Human Resources I 24 Carla Martinez Subsidy or tax arbitrage (reduction in taxes) o Government use them when they want firms to provide benefits to the workforce. Imagine a health plan whose cost for the worker is Price + VAT. The cost for the firm is only the Price. Therefore represents a benefit for workers to acquire it that way o Case: in the US, employer provided health insurance was not common until the tax code was changed to allow such a deduction o Companies can take advantage and use the copayment system under this scheme too Still, there are many other reasons to provide benefits, such as: Employee sorting o Employees with experience o Employees with family o Young Productivity o Employees time o Education Not all the compensation benefits have to be below the market to save costs. Instead, some firms may decide to offer above the market compensation because it generates motivation and could minimize voluntary turnover.
Efficiency wages ̅ If workers are monitored (supervised) If they Worked: Efficiency wage If they Shirked: fired (going wage) The problem is the following: Firms are competing. If it pays one firm to raise its wage, it will pay all firms to raise their wages, then does the incentive not to shirk disappear? Unemployment The probability of being caught shirking (q) is increasing in the intensity of supervision. In this isoquant, efficiency wages and supervisors are substitutes Human Resources I 25 Carla Martinez TOPIC 6: Promotions Promotions play a dual role: incentives versus sorting. For example, you have a position to fill in your management hierarchy, who should you give the position to? Best performers in the lower job vs employee who has the most potential to perform well in the higher level job. Sometimes this decision may generate a conflict. For instance, in the case of an R&D manager, would you promote the best researcher to manage the group? He may be an optimal researcher but not capable of managing a group, or may create a negative incentive to lower-level researchers to achieve the managing role, etc. Then, what to do? Avoid using promotions as incentives. But then, how do you motivate researchers? Pay for performance or More discretion.
The promotion rule: Tournament versus Standard Tournament: The firm ends up promoting the employee with the best performance. Regarding quality, under this scheme it is more variable. It’s based on relative evaluation which might distort (reduce) incentives for workers to cooperate or can generate a “sabotage effect” o Solutions Measure the degree of cooperation and sabotage: Although it may be hard to detect and to quantify Broader performance measure: although it increases risk Standard: fixed job slots Standard: the firm promotes any whose performance meets some fixed threshold. Gives better control over the quality of workers. It’s based on absolute evaluation.
How do promotions generate incentives? Deeper on Recall from the previous maximization problem that: It depends on two elements Now suppose that W1 (base salary) W2 (after the raise) ∆W = W2 – W1 (prize or spread) accounts for the intensity of incentives pr (promoted), pr (not promoted) Wage expectations for workers can be summarized by: E(W) = P(prom)W2 + P(no prom)W1 E(W) = P(prom)W2 + 1-P(prom)W1 E(W) = W1 + (W2-W1)P(prom) E(W) = W1 + (∆W)P(prom) The prize itself: includes two motivational benefits when the worker earns the promotion o The raise itself o Improves the perspective of the worker, and generates the ability to compete for the next promotion The level of salaries W2, W1: used to make sure that the firm is able to recruit and retain the appropriate quality of employees (skills, effort and risk) Affects all stages of the hierarchy, for instance: Having the option for a pay rise from level 1 to 2 affects levels 1 and 2 Having the option for a pay rise from level 5 to 6 affects levels 1, 2, 3, 4, 5, 6.
It is more important to give large prizes at higher levels because these prizes provide incentives for more employees Human Resources I 26 Carla Martinez ( FOC w.r.t effort ) , therefore incentives depend on two factors: the Size of the prize and how likely is the employee to be promoted.
( An increase in ) (how the probability of winning the position varies with the level of effort), therefore will lead to an increase in effort IF & ONLY IF the worker thinks that the opponent is similar (in terms of skills, effort, etc).
If the competitor has more or less the same chances to win the promotion, the worker will be more motivated. In other words, the probabilities of getting the promotion, have to be at intermediate levels: it won’t work if the probability of winning is too high, and won’t work either if they are too low.
Then, another important conditionant is luck, which reduces incentives because it varies the level of control workers have of their abilities. In context, typically when luck is important, incentives will be low.
Two different cases: Japan: Managers are promoted later because then, they would have been observed for a long time and the likeliness that random events will play an important role is low.
USA: Workers are promoted at lower stages of their career, when they are younger. As the possibility that random events will happen is large, also will be the spread offered. It acts to compensate the luck factor.
Empirical evidence Several studies have examined if larger prizes lead to better performance in sporting contest like golf and these results tend strongly to support this prediction At the same time, laboratory experiments show that 1. Larger prizes induce greater effort 2. Greater risk induce less effort 3. Lower probability of winning induces less effort Formal Analysis The worker’s optimization + ( ( ) The firms’s optimization problem ( ) S.t.
( ) ( ) ) ( (simply: MBe = MCe) The larger the prize, the greater the incentive to FOC: put more effort ( If you want the worker to increase the level of ( ) ( effort you have to improve by ) C ) ) o Reducing the effect of luck o Improving measurement error The riskier the performance evaluation, the weaker the incentive Substituiting in the workers effort supply ( ) Human Resources I 27 Carla Martinez Which means that optimal prize spread should be larger if the risk in performance evaluation is larger TOPIC 7: Seniority pay and incentives Increases in earnings come not just from promotions, but from raises in salary over time, which can also be used as a long term incentive.
The model that has been developed lies on some assumptions: If the worker puts high level of effort → V output will be generated over the career If the worker puts low level of effort → V’ output will be generated over the career High effort would be the efficient choice There exists a performance evaluation system through which, if the worker shirks in any period, there is some probability that the firm will detect the shirking, in which case the worker is fired Alt is the value of the worker’s alternative use of time T is the date that a worker should retire W is a possible wage profile (the discounted present value of W from 0 to T is equal to V) There are two ways to compensate workers o Paid V: she receives the exact value of output o Pay W: she receives less than productivity until time t0 and more than productivity thereafter Why bother distorting the wage profile like this? Incentives are not the same along each profile Now suppose that the firm pays V at every stage of the career. Consider the worker’s incentive on the last day before retirement at T. If the worker shirks, there is nothing to lose, since the worker is not employed tomorrow anyway. Therefore, at any time near retirement, the worker has little incentive, because the loss from being fired (V Alt) is very low Therefore, the solution is to pay W. As the worker has a stronger incentive to provide high effort, the more the pay is deferred. The main problem related to this solution is default risk: When workers are young they act as creditors and until t0 the worker produces V0 but receives only W0.
Therefore, there exists an implicit loan that has to be repaid.
Human Resources I 28 Carla Martinez At time t0, the worker has loaned the firm an amount equal to the triangle 1. Triangle 2 acts as the repay the company has to make to the employee. From t0 and on the firm is paying the worker more than he is worth, so the firm would like to terminate the worker at time t0 Then, what keeps the firm from firing a worker? Reputation: If the company keeps firing workers at time t0 it may be likely to find it difficult hiring workers in the future Seniority-based schemes are more likely to work in older firms (rather than startups) and in less risky business environments.
The Work-leisure decision distortion: Workers have incentives to stay at the firm after T, as PV (W) > PV (V). The solution may be mandatory retirement, but in some countries it may be illegal, so other incentives should be generated by the company.
Evidence from Plant Level Data (Bayo-Moriones, Galdon-Sanchez and Güell 2004) Is Seniority-Based Pay Used as a Motivation Device? This study was aimed at concluding if compensation linked to seniority served to provide incentives. The background of the study included blue collar workers of Spanish manufacturing firms and was mainly conducted through interviews to general managers or human resources managers.
The main hypothesis was: Seniority-based pay should be a replacement of both monitoring and performance pay The results were: Companies using seniority-based payments are less likely to use performance-based payment monitoring TOPIC 8: Design of the job position Delegation of decision-making & Incentives versus Centralization When should decisions be delegated? When Agents have private knowledge or superior information vis-à-vis the principal regarding how perform the job or when knowledge or information cannot be communicated. We can find some examples when information is perishable or complex.
Benefits for decentralization Benefits for centralization Develops management skills Coordination.
For instance, when one o As they are a form of human capital that, to a good extend, must division’s product is be learned on the job used by a different o Also allow the firm to train managers who can then be promoted division as part of the into higher positions creation of their Intrinsic motivation product o The job may be more challenging and interesting to the worker, Reduces agency costs therefore he may be more intrinsically motivated to perform the work diligently Pay-for-performance The basic principal-agent problem, where we have a contract: (w, e*), where e cannot be monitored and therefore, represents a moral hazard. This contract is also based on a pay = a + b.PM in which, PM = e + ε (which accounts for risk) Human Resources I 29 Carla Martinez Normally workers are risk averse so they require a risk premium for accepting pay-for-performance. The Central result of the agency model is that there’s a Negative association between the degree of risk of the PM and the intensity of incentives Empirical evidence shows that: Under the information context of uncertainty, pay-for-performance is settled as the designed job position Private knowledge usually leads to Autonomy and in turn to, pay-for-performance.
In a study conducted, there were three hypotheses: H1: Pay-for-performance is negatively related to Uncertainty H2: Pay-for performance is positively related to Autonomy H3: Autonomy is positively related to private knowledge The data came from database containing human resources practices for blue collar workers in Spanish industrial (358) plants. The variables studied were: Pay-for-performance, autonomy Private knowledge (job complexity) Uncertainty (variability in product demand) The econometric approach J pi* 1ui 2 jci 3ai j x ji 1,i j 1 J ai* 1ui 2 jci j x ji 2,i j 1 Where: u jc a p uncertainty job complexity autonomy pay-for-performance Objectives congruence (self-regarding preferences versus other-regarding preferences) Traditional analysis of the organization states that workers’ objectives are in conflict with those of the organization (Agency model (e), models of delegation of decision-making (i)), but this approach ignores that in many circumstances workers believe in the mission of the organization (i.e., there is congruence of objectives) Actually, objectives congruence can operate as a substitute for incentives as it reduces the cost for the agent of exerting effort and at the same time, it encourages delegation of decision-making as agents are seen more trustworthy.
Empirical evidence shows that: Under the objectives congruence, pay-for-performance and autonomy are settled as the designed organization H1: Pay-for-performance is negatively related to objectives congruence H2: Autonomy is positively related to objectives congruence The information was extracted from HR practices for teachers of childcare facilities in Minnesota, accounting for a sample of 206 cases. The variables studied were: Pay-for-performance, autonomy and mission congruence Human Resources I 30 Carla Martinez The econometric approach J pi* 1mi 2 ai j x ji 1,i j 1 J ai* 1mi j x ji 2,i Where: m mision congruence a autonomy p pay-for-performance j 1 Autonomy, Monitoring and Efficiency Wages The aim of the efficiency wage is to raise the opportunity cost of shirking. Under this scheme workers are going to be monitored. If they have worked they would get the efficiency wage but if they shirked, discharge. The implications are: The higher the efficiency wage, the lower the probability of being detected shirking (q) The higher intensity of supervision, the higher the probability q (of being caugh shirking) Efficiency wages and supervisors are substitutes, and this is represented by Isoquants.
Autonomy and Monitoring Under the autonomy scheme, the job can be done in several ways; therefore it is more difficult to monitor. This can be represented by the following formula: q (1 d ) m , where d acts as the null: d = 0, worker doesn’t have autonomy; d = 1, the worker has autonomy. Therefore, with autonomy the firm must increase the intensity of monitoring in order to maintain the level of q.
Empirical evidence shows that autonomy leads to higher monitoring and this, at the same time, to lower efficiency wages, and those are the hypothesis of the numerical study.
The numerical study took as a database human resources practices for blue collar workers in (358) Spanish industrial plants. The variables studied were autonomy, monitoring and wages.
The econometric approach J m *i 1ai j x ji m,i j 1 J r *i 1ai 2 mi j x ji r ,i Where: a autonomy m monitoring r efficiency wages j 1 Teams Firms exist because working together is more productive than working as individuals. However, the firm must know how to set up teams and motivate team members and at the same time recognize the benefits and costs of team production.
Human Resources I 31 Carla Martinez Some of the disadvantages regarding the use of teams are: They violate the principle of clear hierarchy: important to establish a clear team leader to efficiently resolve disputes o Decision-making tend to be faster and more Example of a Free-riding problem: straightforward when there is a single, clear leader There are 5 workers, that if complete o Maybe in too much discussion over key decisions the project in a timely manner, obtain a bonus of $ 100, which is split evenly.
Free riders o Workers can hide behind the productivity of others The individual case of Xavi: He has to o The free rider effect dilutes incentives choose between staying late to work on the project or watch the World Cup. If Then, why is it useful to use teams? he Works, he will earn 20$. In the end, Complementarity Xavi goes home and watch the World o If tasks are complements in production Cup o If the individual that diagnoses the problem also repairs it Why? The worker who bears the pain of o In cases of Multitasking (but in case of so many tasks that toiling does not reap the full benefits are complementary the resulting job will be overwhelming for one worker SOLUTION: Paying individuals rather o Teams who work closely together than teams or trying to observe Specialization individual effort.
o If there’s an important reason why individuals work together o Each individual can specialize her human capital investments and be assigned a subset of all the tasks o If workers collaborate o If it is complemented with job rotation Implementation of teams It is important to take into account: Job rotation Team size o large teams create communication problems o When the group is small, the free-rider has incentives not to act accordingly as it could be easily identified → peer monitoring can be effective in small groups A worker is likely to know what the other worker is doing to a much greater extend in an small group than in a large group In a small group one partner’s reduced effort has a significant effect on the earnings of the other partner In large teams, peer monitoring is not as effective: the shirk of one member does not affect another member’s interest as much and it is more difficult to observe shirkers in large teams ...