STUDY GUIDE FOR BARON AND KREPS
This chapterís main purpose is to explain the authorsí perspective and to start hitting a few key themes. The ones I consider most critical are:
This chapter lays out the "five factors" framework, which I went over in class with special emphasis on the technology factors. This framework can be used to examine how HR policies fit with the organizationís strategy in case analysis or your course project. The IBM example shows how the analysis can be applied and is instructive in that regard.
One key issue in the 4th factor is whether a firm should have a uniform set of HR policies and, if not, how to decide which parts of the firm should have different policies. Possible dividing lines include occupation, location, and product.
The main theme of this chapter is the internal consistency of HR policies. There are three main dimensions (single-employee, among-employee, temporal). You should know why each is desirable. You also should be able to give examples of policies that are (HP) and arenít (Portman Hotel) consistent with each other. This chapter goes further into the span of consistency issue and gives specific examples of when distinctions can be made (occupation, location, organizational boundaries) and when they should not be made (people working together, strong organizational cultures, internal labor markets). The closing point is that one should not get locked into consistency; maintaining continuity and the informal, implicit expectations that have built up over time can be overriding factors in some situations.
The highlights of this chapter are as follows:
The material on staffing economies (p. 189) through diffusion of ILMs (top of p.194) will not be covered on the exam.
After reading this chapter, you should be able to address the following issues:
The Safelite example is used to motivate a discussion of base pay systems. The first and most basic decision is whether to pay piece rates (based on output) or time rates (hourly wages or salary). Firms find piece rates attractive because they tax on-the-job leisure (or equivalently reward performance) and attract highly productive workers, while scaring away the slackers.
The chapter then goes into a discussion of the principal-agent problem. In a nutshell, employees prefer a stable income stream to one with the same mean and a higher variance. They also would rather shirk than work. Since the correlation between labor effort and dollar outcome is noisy (the dollar outcome depends on many other things in addition to work effort), any attempt to create incentives and encourage work effort also shifts more risk to the employee. The optimal contract must balance risk and reward (if this sounds like something from finance class, youíre right; it also applies to sharecropping and other economic problems). One key implication for HR: the usefulness of incentives declines with uncertainty (or equivalently, incentives become more practical when workers have more control). The more elaborate situations in agency theory involve (1) getting the worker to do what the firm wants, (2) benchmarking, (3) ratchet effects, and (4) time and hurdle levels.
The rationale for giving pay raises versus bonuses is considered in some detail. The calculations can become a bit numbing, but the key point is that employers can provide the same NPV with bonuses as they do with raises. Since bonuses give employers a lot more flexibility than raises, they have become increasingly popular (for other reasons, see p. 286).
Group incentives are discussed on pp. 287-293; these systems work best in smaller groups (lower odds of free riding) and when peer pressure is strongest. Also be familiar with the arguments made against pay for performance schemes (pp. 295-298). The chapter closes with a further examination of the Safelite system and the factors that tend to make piece rate systems work (or work all too well).
Key points to remember:
This chapter begins by noting the importance of hiring decisions. Firms will obviously seek workers whose characteristics fit with the firmís strategy and environment. There is a brief discussion of the tradeoffs involved with diversity.
The bulk of the chapter deals with selection. Firms can encourage the right applicants through compensation, reputation, and job characteristics. Probationary periods may seem like an ideal screen at first glance, but there are problems Ė the most notable of which are high turnover and the ability of applicants to game the system.
There is a very long discussion (pp. 372-381) of credentials that can be used to predict productivity. The authors spend a lot of time explaining why companies may non-intentionally discriminate against certain groups; this is interesting theory, but mainly from a social perspective. The key point to takeaway is that if a credential is correlated with mean performance or the variation in performance, firms have some incentive to use it to screen applicants. (No test questions here.)
The chapter has a good basic discussion of job interviews (pp. 381-383) and employment testing (pp. 383-384). The key points are pretty clear in each of these sections. Make sure you know them. Know the key points on legal issues; skip the material on statistical discrimination.
The first part of the chapter (pp. 403-406) lays out the basic economics of investments in human capital. The firm will invest as long as the present value (PV) of the difference between increased productivity (B) and increased salary and benefits (S) exceeds the cost (C) of the training. The costs consist of lost output, materials and equipment used in training, and the time of trainers (p. 421). With some creativity, reasonable estimates of C can be obtained. The tricky part is estimating the PV of B-S. One clear implication is that firms are more likely to train workers if they think they will have lengthy tenure. B-S also will be greater (p. 406) when (1) few workers are available outside the firm with the necessary skills and (2) the training complements the pre-existing skills. Another payoff from training is its impact on the type of employees the firm is able to attract (p. 409-410).
The text has Beckerís theory on general training correct, but completely messes up his theory on specific training. They forget that firms providing specific training compete in the labor market with firms providing general training and that the PV f lifetime income streams from both have to be equalized (holding the workers" pre-training skills constant). In reality both the firm and the worker share in both the costs and benefits of general training. But rest easy, no test questions on this!
The text makes some very good points on pp. 426-430 about how training decisions are actually made and evaluated. With the benefits hard to measure and the costs not too hard to measure, there is likely a bias leading to underinvestment in training.
Like performance evaluation, promotions serve a number of functions, including incentives (especially for projects with long-term payoffs), signals to workers about what is valued, training, job matching (a point that needs more emphasis, see WSJ "Promotions Are Not a Reward"), and screening. As in the case of performance evaluation, promotions do not serve all of these goals equally well Ė in many cases they may be in direct conflict. Competition for promotions can become dysfunctional (pp. 5-8); if one person is clearly ahead, others may slack off (or even worse conspire to sabotage him). Promotional opportunities decline with seniority, creating the problem of what to do with those who have gotten their last promotion (answer: get them appointments as vice-chancellors at your local university). Possible solutions (which in turn have their own problems) include up-or-out systems, the military system where the losers stay in the same job, and dual-track systems. The material on pp. 450-452 is less critical.
The main points are as follows: