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.
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.
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.
Wage in $
Basic Competitive Model
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.
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.
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.
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.
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.
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.
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.
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.
Tradeoffs in Long-Term
Employee 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.
Pay in Internal Labor Markets
Compensation
Salary
Marginal Revenue
Product 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.
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.
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.
Monetary Compensation
Indifference Curves Between Salaries
and Fringe Benefits
Utility = U2
Utility = U1
Fringe Benefits
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.
Monetary Compensation
Iso-Cost Lines Between Salaries
and Fringe Benefits
$50 K
Iso-cost line at $50,000 ($50K) of total payment
Slope = -1
$50K
Fringe Benefits
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.
Monetary Compensation
Iso-Cost Lines Between Salaries
and Fringe Benefits
$50 K
$30K
$20K
$50K
Fringe Benefits
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.
Fringe Benefits

Payroll taxes



Make the iso-cost line flatter
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.