Promotion as Motivation
Presented by Pei-wen Huang
Tournament theory suggests that the larger the spread between the winner's and
loser's prizes, the higher the effort exerted by both players, and the larger the raise
associated with a given promotion, the greater the incentive to be promoted.
Salary Structure and EffortA salary structure has two features--level and spread.
The spread refers to the difference between the salaries that high and low level
employees receive. The higher the spread, the more anxious is any given employee
to obtain a promotion to the higher-level job. Then each worker puts forth more
effort in an attempt to secure the higher-level job. These results in a higher overall
level of effort as workers are forced into a rat race to attempt to win the higher
position.
The benefit of the rat race is that it produces higher levels of effort and
therefore higher levels of output for the firms as a whole. The cost is that since
workers are putting forth more additional effort, they must be compensated
accordingly.
Salary of
Total
Total
Difference between
Research Salary of
earnings of earning of Winner and Loser
Structure Engineer Project Head Loser
Winner
Earnings
Structure A $50,000
$200,000
$500,000 $1,250,000
$750,000
Structure B $50,000
$100,000
$500,000 $750,000
$250,000
Structure C $100,000 $250,000 $1,000,000 $1,750,000
$750,000
Under structure A, each worker puts forth more effort in an attempt to secure the
higher-level job. This results in a higher overall level of effort as workers are forced
into a rate race to attempt to win the higher position. If workers find effort especially
painful, they would prefer the lower paying job that induces less effort than the higher
paying, higher effort job.
Luck
Noise, or luck, has adverse effects on effort.
When the outcome of a promotion
race is affected by extraneous factors, workers reduce their effort because effort is
less likely to affect the outcome.
To offset the effects of luck, it is necessary to
increase the spread. Thus, salary spreads are greater in work environments where
measurement errors or production uncertainties are large.
New firms and new
industries are most likely to have large luck components and should therefore use
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larger spreads. The amount of luck of noise inherent in the promotion process affects
the appropriate salary structure.
Firms setting up salary structure should take into account that the wage spread
affects worker incentives differently, depending on the amount of luck involved. If the
environment is one where luck is extremely important, then a firm should select a
higher wage spread.
Tournaments and the Organizational Chart
Structure 2 provides more incentive than structure 1...
In the corporation, being promoted from file clerk to clerical supervisor not only
provides the workers with a higher salary, but it also allows him to compete for
subsequent jobs. Thus, the promotion has value even if file clerks and clerical
supervisors earn exactly the same amount.
As the individual moves toward the top of the hierarchy, the option value
diminishes. In the very last round, the winner gets the CEO’s salary and only the
CEO’s salary. Individuals will not work hard to win the CEO’s prize on the basis of
the additional opportunities it affords.
Firms that have symmetric structures, like those shown in structure 1, are likely to
be using some other form of worker motivation such as piece-rate pay or
compensation on the basis of effort.
Firms that reward workers on relative performance rather than absolute
performance are more likely to have structures like the one shown in structure 2.
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When too many workers compete for a promotion that carries with it a small
raise, effort will suffer. Incentives can be produced either by relative comparisons or
by absolute measurements. Piecework provides absolute incentives while
promotions, based on relative performance, provide relative incentives. The
advantages of relative incentives are twofold. First, relative comparisons are often
easier and cheaper to make than absolute judgments. Second, relative
comparisons reduce the effects of common noise, like business conditions or
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supervisor attitude, that would affect pay based on absolute standards.
The
disadvantage of relative incentives is that they may foster either collusion, or induce
negative competition between workers which could be harmful to the firm.
Internal promotion produces favorable incentive effects, but lends itself to
worker collusion. One way to reduce the likelihood of collusion is to hire from the
outside. Therefore, outside hiring should only be used when the outside candidate
is significantly better than all internal candidates, or when insiders have colluded to
put forth too little efforts in the past.
The economic analysis of internal labour markets
The ILM raises a number of issues for economic analysis. First, to what extent is
the pricing and allocation of labor within firms controlled by non-economic variables?
Secondly, to the extent that non-economic variables are important, what are the
implications for economic theory? Thirdly, are the conventional methods of
economics appropriate for empirical research on the ILM or is it necessary to develop
alternative approaches?
A major theme concerns the efficiency aspects of the ILM. Much of the early
work suggested that ILMs, by introducing rigidities which constrain labor market
adjustments, prevent allocative efficiency being achieved and deliberately trade
efficiency for equity. However, later work has viewed the ILM as an efficient
response to uncertainty in a market containing an idiosyncratic factor of production;
the firm's internal market is seen to operate more efficiently than thee external market.
Other models introduce competitive elements and examine the implications of
alternative labor contracts for Pareto efficiency. Nevertheless, some inefficiency is
found to exist due, for example, to over-investment by individuals in signals' to
employers concerning their quality.
A closely related aspect concerns the motivation of workers, although different
authors use their own special vocabulary, making precise comparisons difficult.
Some stress the `negative` aspects of moral hazard and the enforcement of compliance
with the firm's rules, while others stress more `positive` aspects whereby individuals
identify their own interests in terms of the performance of the enterprise. Despite
these differences of emphasis, most authors agree that questions of work effort and
motivation are central to the analysis of the ILM and its rationale.
A related issue concerns the inappropriateness of aggregate data for ILM analysis;
this imposes the need for researchers on the ILM to collect their own data.
The ILM concept was developed by economists in the institutionalist tradition. It
represents the integration of a wide range of ideas on labour market structure, labour
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mobility, wage determination.
Such observations could be explained in a number of different ways, including
measurement inaccuracies, imperfect information or worker inertia. However, those
who believed that the explanation was more deepseated directed their attention
towards the nature of the employing organization. Doeringer and Piore explained
low mobility by the efforts of employers to reduce turnover because of the presence of
skill-specificity. Internal mobility is seen to represent a compromise between
promotion by seniority and by ability; it is suggested that the former is more
acceptable to the worker and the latter to the employer.
Doeringer and Piore suggested that there are three principal elements of the ILM
wage structure;(i) the plant wage level; (ii) the vertical differentiation and (iii) the
horizontal differentiation of the wage structure.
Neoclassical Analyses
In dealing with the ILM, neoclassical economists have concentrated on only a small
number of the characteristics which distinguish it from wage competition, such as low
turnover, internal promotion and seniority.
While the bulk of the neo-classical literature has only indirectly examined the ILM,
two related strands have examined it more directly. The most direct analysis is the
work of Williamson (1975). This research has variously been called the transaction
cost approach or the theory of idiosyncratic exchange. The second type of direct
analysis is the more disparate literature on market signaling, selection models and
principal agent analyses.
Transaction Costs
Two basic behavioural assumptions are made. First, individuals are assumed to
have bounded rationality'. Secondly, workers are assumed to be ` opportunistic`; they
would not honestly disclose all the information they have.
Signalling and Incentives
The fact that the seller of a good has more information about its quality than
potential buyers involves the use of various signals. Such signaling involves
self-selection processes -- whereby the course of action taken by the seller differs
according to the quality of the good being sold. It must be unprofitable for low
quality sellers to imitate the signals of the higher quality sellers. Despite the
somewhat different focus of this literature many contributions have been explicitly
concerned with labour markets and have described their results as producing features
of ILMs.
The disparate contributions to the signaling/incentive literature have been
synthesized and termed efficiency wage models. Efficiency wage models explain why
firms find it unprofitable to reduce wages when there is high unemployment. In
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brief, wage cuts are said to harm productivity and therefore,
Institutional and Radical Analyses
The recognition of non-economic determinants of the ILM has evoked a mixed
response from economists in terms of theory construction. Neoclassicists have
suggested the ILMs slow down the basic processes which are outlined in the wage
competition model but that the model when modified is still applicable.
Institutionalists have searched for alternative models, such as job competition and
dual labour markets, but have not been able to convince the bulk of economists of the
utility of these constructs. Radicals view the ILM as confirming the superiority of
an economic model grounded in Marxian rather than neoclassical concepts. The
ILM has thus simply re-oriented the debate between the schools of thought.
Empirical Studies
The ILM poses special problems for empirical analysis. First, it is a complex
phenomenon which cannot be reduced to a small number of measures. Secondly, its
characteristics have been shown to vary considerably across space and time in a
manner that is not readily understandable. Thirdly, many of its principal dimensions
are longitudinal in nature and cannot be analysed using cross-sectional date. The
major consequence of these problems is that the types of data normally used by
economists are not useful for ILM research. In particular, ILM research requires that
researchers collect their own data.
Empirical research on the ILM has generally adopted three main types of approach.
The first involves the analysis of highly aggregative data; the second is based on
case studies of particular firms and industries, using data collected specially by
researchers; the third type concentrates on the analysis of career histories, usually of
particular occupational groups.
Low turnover rates have been found in many sectors and occupations.
The filling of upper level positions by internal promotion has been shown to be a very
common practice.
It was shown that the experience of internal mobility is a key determinant of
earnings. Osterman found that movement between job ladders was relatively easy at
the entry position but less so at higher levels. The empirical research has also shown
that wages are tied to jobs within ILMs and that they are not very responsive to
changing labour market condition.
Crockett (1983) found that firms operating ILMs exhibited rigid salary structures
but showed a great deal of flexibility in moving workers between jobs at differing
points on the classification: that is, the wages for workers were more flexible than the
wages for jobs. The key finding is that wages represent a highly constrained
adjustment mechanism.
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While they would reduce total labour costs, they may increase labour costs per
efficiency unit. This simple hypothesis has been used to explain the rigidity of real
wages, they existence of dual labour markets, the payment of differing wages to
similar workers and discrimination between distinct groups.
Institutional
This hypothesis argues that the labour market can be divided into two sectors -
a
primary sector composed of 'good' jobs and a secondary sector composed of 'bad'
jobs.
Wage and employment competition which is postulated to promote labour market
efficiency in the neoclassical model, is therefore seen by Tthurow to give workers an
incentive to hoard knowledge.
The job competition model therefore emphasizes quantity adjustment rather than
wage adjustment.
Edwards (1975), for example, has contended that firms established ILMs to
prevent the development of class consciousness among workers and to allow
employers to maintain control over the production process.
The ILM is therefore
said to maximize the amount of labour (effort expended in production) obtained
from a given amount of labour power (the capacity to perform useful work).
This
requires bureaucratic control, involving the development of formal definitions for
the direction of work tasks and the use of institutionalized power to enforce
compliance. Thus work habits become consistent with the form of bureaucratic
control rather than with the actual work tasks.
Future studies may want to examine the general pattern of
workers' career
mobility across industries or organizations in Taiwan and the diversities of internal
labor market formations.
Althauser and Kalleberg suggested that there are three characteristics of the ILM:
(i) job ladder (2) entry only at the bottem.(3)promotion represents on
improvement of technologe.
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