PERSONNEL ECONOMICS IN PRACTICE

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1 PERSONNEL ECONOMICS IN PRACTICE Second Edition Edward P. Lazear Stanford University Michael Gibbs University of Chicago WILEY John Wiley & Sons, Inc.

CONTENTS ABOUT THE AUTHORS PREFACE ACKNOWLEDGMENTS vii ix xv PART ONE SORTING AND INVESTING IN EMPLOYEES 1 CHAPTER 1 CHAPTER 2 SETTING HIRING STANDARDS An Example: Hiring Risky Workers New Hires as

2 CONTENTS ABOUT THE AUTHORS PREFACE ACKNOWLEDGMENTS vii ix xv PART ONE SORTING AND INVESTING IN EMPLOYEES 1 CHAPTER 1 CHAPTER 2 SETTING HIRING STANDARDS An Example: Hiring Risky Workers New Hires as Options Analysis A Counterargument Setting Hiring Standards Balancing Benefits Against Costs Foreign Competition The Method of Production How Many Workers to Hire? Other Factors Making Decisions with Imperfect Information Make a Decision Independent ofanalysis Estimate the Relevant Information Experiment RECRUITMENT Screening Job Applicants Credentials Learning a Worker's Productivity Is Screening Profitable? For Whom? Probation XIX

3 xx Contents CHAPTER 3 CHAPTER 4 Signaling Who Pays, and Who Benefits? Examples Signaling More Formally: Separating and Pooling Equilibria Which Type of Firm is More Likely to use Signaling? INVESTMENT IN SKILLS Matching Investments in Education Effects of Costs and Benefits Was Benjamin Franklin Correct? Investments in On the Job Training General vs. Firm-Specific Human Capital Who Should Pay for Training? Implications of On the Job Training Rent Sharing and Compensation Implicit Contracting MANAGING TURNOVER Is Turnover Good or Bad? Importance of Sorting Technical Change Organizational Change Hierarchical Structure Specific Human Capital Retention Strategies Reducing Costs of Losing Key Employees Embracing Turnover Bidding for Employees Raiding Other Firms: Benefits and Pitfalls Offer Matching

Contents xxi Layoffs and Buyouts 96 Who to Target for Layoffs 96 Buyouts 99 104 105 105 106 106 PART Two ORGANIZATIONAL AND JOB DESIGN 107 CHAPTERS DECISIONMAKING 109 109 The Organization of an

4 Contents xxi Layoffs and Buyouts 96 Who to Target for Layoffs 96 Buyouts PART Two ORGANIZATIONAL AND JOB DESIGN 107 CHAPTERS DECISIONMAKING 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 111 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 CHAPTER 6 ORGANIZATIONAL STRUCTURE Types of Organizational Structures 145 Hierarchy 145 Functional Structure 147 Divisional Structure 148 Matrix or Project Structure 153 Network Structure 155

5 xxii Contents Which Structure Should a Firm Use? 157 Coordination 158 Two Types of Coordination Problems 158 Coordination Mechanisms 160 Impl ementation 163 Span of Control and Number of Levels in a Hierarchy 163 Skills, Pay, and Structure 166 Evolution of a Firm 's Structure CHAPTER 7 JOB DESIGN Patterns of Job Design 174 Optimal Job Design: Skills, Tasks, and Decisions 177 Multiskilling and Multitasking 111 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 CHAPTER 8 ADVANCED JOB DESIGN 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

Contents xxiii High Reliability Organizations 222 224 226 226 227 227 PART THREE PAYING FOR PERFORMANCE 231 CHAPTER 9 PERFORMANCE EVALUATION 237 237 Purposes of Performance Evaluation 238 Ways to

6 Contents xxiii High Reliability Organizations PART THREE PAYING FOR PERFORMANCE 231 CHAPTER 9 PERFORMANCE EVALUATION 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 CHAPTER 10 REWARDING PERFORMANCE How Strong Should Incentives Be? 264 Intuition 264 Imperfect Evaluations and Optimal Incentives 269 : How Strong Should Incentives Be? 272 Paying for Performance: Common Examples 273 Rewards or Penalties? 21Ъ Lump Sums, Demotions, or Promotions 276 Caps on Rewards 278 Applications 280 Profit Sharing and ESOPs 280 Organizational Form and Contracting 282 Motivating Creativity 2 84

xxiv Contents CHAPTER 11 CHAPTER 12 CAREER-BASED INCENTIVES Promotions and Incentives Should Promotions be Used as an Incentive System? Promotion Rule: Tournament or Standard?

7 xxiv Contents CHAPTER 11 CHAPTER 12 CAREER-BASED INCENTIVES Promotions and Incentives Should Promotions be Used as an Incentive System? Promotion Rule: Tournament or Standard? How Do Promotions Generate Incentives? Advanced Issues Turnover Evidence Career Concerns Seniority Pay and Incentives Practical Considerations OPTIONS AND EXECUTIVE PAY Employee Stock Options Stock Options-A Brief Overview Should Firms Grant Employees Options? Options as Incentive Pay Executive Pay What is the Most Important Question? Executive Pay for Performance Other Incentives & Controls Do Executive Incentives Matter? Employee Stock Options Executive Pay

Contents xxv PART FOUR APPLICATIONS 347 CHAPTER 13 BENEFITS 349 349 Wages vs. Benefits 349 Why Offer Benefits?

8 Contents xxv PART FOUR APPLICATIONS 347 CHAPTER 13 BENEFITS 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 CHAPTER 14 ENTREPRENEURSHIP AND INTRAPRENEURSHIP Entrepreneurship 3 76 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 CHAPTER 15 THE EMPLOYMENT RELATIONSHIP Employment as an Economic Transaction 397 Perfect Competition 397 Imperfect Competition 398 Complex Contracting

xxvi Contents Communication between Management and Workers 403 CommunicationfromManagement to Workers 403 Communication from Workers to Management 405 The Decision to Empower Workers 408 Improving

9 xxvi Contents Communication between Management and Workers 403 CommunicationfromManagement 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 Personnel Economics in Practice GLOSSARY 435 INDEX 445

Third Edition. Edward P. Lazear. Stanford University. Michael Gibbs. University of Chicago WILEY

Third Edition. Edward P. Lazear. Stanford University. Michael Gibbs. University of Chicago WILEY FERSONNEL ECONOMICS IN PRACTICE Third Edition Edward P. Lazear Stanford University Michael Gibbs University of Chicago WILEY CONTENTS ABOUT THE AUTHORS PREFACE ACKNOWLEDGMENTS iii v ix PART ONE SORTING