Personnel Economics in Practice

Edward P. Lazear, senior fellow at the Hoover Institution of War, Revolution and Peace since 1985, is also the Jack Steele Parker Professor of Human Resources, Management and Economics at Stanford University's Graduate School of Business. Current and founding editor of the Journal of Labor Economics, and past president of the Society of Labor Economists, Professor Lazear is the visionary leader in the field of human resource management. Michael Gibbs is Clinical Professor of Economics at the University of Chicago Graduate School of Business. Gibbs earned his PhD in Economics from the University of Chicago. He is a leading empirical researcher in the field of personnel economics, and has received awards for excellence in research and teaching.

• ABOUT THE AUTHORS vii PREFACE ix ACKNOWLEDGMENTS xv PART ONE SORTING AND INVESTING IN EMPLOYEES 1 CHAPTER 1 SETTING HIRING STANDARDS 3 An Example: Hiring Risky Workers 3 New Hires as Options 3 Analysis 5 A Counterargument 7 Setting Hiring Standards 9 Balancing Benefits Against Costs 10 Foreign Competition 12 The Method of Production 13 How Many Workers to Hire? 16 Other Factors 17 Making Decisions with Imperfect Information 18 Make a Decision Independent of Analysis 18 Estimate the Relevant Information 19 Experiment 19 Summary 20 Study Questions 21 References 22 Further Reading 22 Appendix (available online) 22 CHAPTER 2 RECRUITMENT 25 Introduction 25 Screening Job Applicants 26 Credentials 27 Learning a Worker s Productivity 28 Is Screening Profitable? For Whom? 31 Probation 32 Signaling 33 Who Pays, and Who Benefits? 36 Examples 37 Signaling More Formally: Separating and Pooling Equilibria 38 Which Type of Firm is More Likely to use Signaling? 40 Summary 40 Study Questions 42 References 42 Further Reading 43 Appendix (available online) 43 CHAPTER 3 INVESTMENT IN SKILLS 47 Introduction 47 Matching 49 Investments in Education 50 Effects of Costs and Benefits 52 Was Benjamin Franklin Correct? 54 Investments in On the Job Training 57 General vs. Firm-Specific Human Capital 60 Who Should Pay for Training? 63 Implications of On the Job Training 69 Rent Sharing and Compensation 72 Implicit Contracting 74 Summary 75 Study Questions 77 References 78 Further Reading 78 Appendix (available online) 78 CHAPTER 4 MANAGING TURNOVER 81 Introduction 81 Is Turnover Good or Bad? 81 Importance of Sorting 82 Technical Change 83 Organizational Change 83 Hierarchical Structure 84 Specific Human Capital 84 Retention Strategies 84 Reducing Costs of Losing Key Employees 87 Embracing Turnover 88 Bidding for Employees 89 Raiding Other Firms: Benefits and Pitfalls 89 Offer Matching 93 Layoffs and Buyouts 96 Who to Target for Layoffs 96 Buyouts 99 Summary 104 Study Questions 105 References 105 Further Reading 106 Appendix (available online) 106 PART TWO ORGANIZATIONAL AND JOB DESIGN 107 CHAPTER 5 DECISION MAKING 109 Introduction 109 The Organization of an Economy 109 Markets as Information Systems 110 Markets as Incentive Systems 112 Markets and Innovation 112 Benefits of Central Planning 113 The Market as Metaphor for Organizational Design 114 Benefits of Centralization 117 Economies of Scale or Public Goods 117 Better Use of Central Knowledge 118 Coordination 118 Benefits of Decentralization 120 Specific vs. General Knowledge 120 Other Benefits of Decentralization 122 Authority and Responsibility 123 Decision Making as a Multistage Process 124 Flat vs. Hierarchical Structures 126 Investing in Better Quality Decision Making 133 Summary 136 Study Questions 138 References 138 Further Reading 139 Appendix (available online) 139 CHAPTER 6 ORGANIZATIONAL STRUCTURE 143 Introduction 143 Types of Organizational Structures 145 Hierarchy 145 Functional Structure 147 Divisional Structure 148 Matrix or Project Structure 153 Network Structure 155 Which Structure Should a Firm Use? 157 Coordination 158 Two Types of Coordination Problems 158 Coordination Mechanisms 160 Implementation 163 Span of Control and Number of Levels in a Hierarchy 163 Skills, Pay, and Structure 166 Evolution of a Firm s Structure 167 Summary 168 Study Questions 170 References 170 Further Reading 171 CHAPTER 7 JOB DESIGN 173 Introduction 173 Patterns of Job Design 174 Optimal Job Design: Skills, Tasks, and Decisions 177 Multiskilling and Multitasking 177 Decisions 183 Complementarity and Job Design 184 When to Use Different Job Designs 186 Taylorism 186 Factors Pushing Toward Taylorism or Continuous Improvement 188 Intrinsic Motivation 192 Summary 194 Study Questions 197 References 197 Further Reading 198 Appendix (available online) 198 CHAPTER 8 ADVANCED JOB DESIGN 201 Introduction 201 Teams 202 Group Decision Making 202 Free Rider Effects 202 When to Use Teams 203 Other Benefits of Team Production 205 Implementation of Teams 209 Team Composition 212 Worker-Owned Firms 214 Effects of Information Technology 215 Effects on Organizational Structure 215 Effects on Job Design 219 High Reliability Organizations 222 Summary 224 Study Questions 226 References 226 Further Reading 227 Appendix (available online) 227 PART THREE PAYING FOR PERFORMANCE 231 CHAPTER 9 PERFORMANCE EVALUATION 237 Introduction 237 Purposes of Performance Evaluation 238 Ways to Evaluate Performance 238 Quantitative Performance Measurement 238 Risk Profile 239 Risk vs. Distortion: Performance Measure Scope 241 Match of the Performance Measure to Job Design 244 Manipulation 246 Subjective Evaluation 247 Why Use Subjective Evaluations? 248 The Benefits of Subjective Evaluations 251 Practical Considerations 253 Summary 257 Study Questions 258 References 259 Further Reading 259 CHAPTER 10 REWARDING PERFORMANCE 261 Introduction 261 How Strong Should Incentives Be? 264 Intuition 264 Imperfect Evaluations and Optimal Incentives 269 Summary: How Strong Should Incentives Be? 272 Paying for Performance: Common Examples 273 Rewards or Penalties? 273 Lump Sums, Demotions, or Promotions 276 Caps on Rewards 278 Applications 280 Profit Sharing and ESOPs 280 Organizational Form and Contracting 282 Motivating Creativity 284 Summary 285 Study Questions 286 References 287 Further Reading 287 Appendix (available online) 287 CHAPTER 11 CAREER-BASED INCENTIVES 293 Introduction 293 Promotions and Incentives 296 Should Promotions be Used as an Incentive System? 296 Promotion Rule: Tournament or Standard? 298 How Do Promotions Generate Incentives? 303 Advanced Issues 308 Turnover 312 Evidence 312 Career Concerns 313 Seniority Pay and Incentives 314 Practical Considerations 316 Summary 317 Study Questions 319 References 320 Further Reading 320 Appendix (available online) 321 CHAPTER 12 OPTIONS AND EXECUTIVE PAY 325 Introduction 325 Employee Stock Options 326 Stock Options A Brief Overview 326 Should Firms Grant Employees Options? 327 Options as Incentive Pay 329 Executive Pay 333 What is the Most Important Question? 334 Executive Pay for Performance 334 Other Incentives & Controls 337 Do Executive Incentives Matter? 338 Summary 342 Employee Stock Options 342 Executive Pay 342 Study Questions 343 References 343 Further Reading 344 Appendix (available online) 344 PART FOUR APPLICATIONS 347 CHAPTER 13 BENEFITS 349 Introduction 349 Wages vs. Benefits 349 Why Offer Benefits? 353 Cost Advantage 353 Value Advantage 354 Government Mandate 356 Implementation of Benefits 357 Improving Employee Sorting 357 Cafeteria Plans 358 Pensions 360 Paid Time Off 368 Summary 371 Study Questions 372 References 373 Further Reading 373 CHAPTER 14 ENTREPRENEURSHIP AND INTRAPRENEURSHIP 375 Introduction 375 Entrepreneurship 376 The Choice to become an Entrepreneur 377 Intrapreneurship 385 Internal Markets 386 Creativity vs. Control 388 Speed of Decision Making 390 Reducing Bureaucracy 390 Continuous Improvement 391 Summary 393 Study Questions 393 References 394 Further Reading 395 Appendix (available online) 395 CHAPTER 15 THE EMPLOYMENT RELATIONSHIP 397 Introduction 397 Employment as an Economic Transaction 397 Perfect Competition 397 Imperfect Competition 398 Complex Contracting 400 Summary 402 Communication between Management andWorkers 403 Communication from Management to Workers 403 Communication from Workers to Management 405 The Decision to Empower Workers 408 Improving Cooperation 414 From the Prisoner s Dilemma to Employment 417 Reputation and the Employment Relationship 418 Investing in Reputation 419 Summary 425 Personnel Economics in Practice 425 Study Questions 427 References 428 Further Reading 428 Appendix (available online) 429 GLOSSARY 435 INDEX 445