An Analysis of Employee Turnover Based on Behavioral Economics
Ke-da Gao
Zhejiang Gongshang University
Hangzhou China
(Gaokeda.0602@yahoo.com.cn)
Abstract - With the deepening of China’s social and
economic transformation, companies are faced with an
increasingly common phenomenon of employee turnover,
which seriously impedes the development of companies.
Based on the "irrational person" perspective of behavioral
economics, this article analyzes the problem of employee
turnover from Prospect theory, Anchoring effect and Mental
account theory which are different from those of traditional
economics, and illustrates how irrational factors affect
employees to make a decision to quit, therefore companies
can have a more realistic and reasonable understanding of
the phenomenon of employee turnover.
Keywords -behavioral economics, irrationality, employee
turnove
I. Backgrounds and Significance
Employee turnover is an important issue that
enterprise managers must pay attention to, especially, the
quit of those key employees would have an impact on
normal operation of the enterprise, and even hinder the
development of the enterprise. the loss of many
employees always makes the managers feel confused
because a lot of employee turnover in real situations are
often "irrational" behaviors. Therefore, enterprises should
have a reasonable and comprehensive understanding of
employee turnover. According to the Mercer Management
Consulting in 2011 for 17 markets worldwide survey of
more than 30,000 employees (including the 2000
employees in mainland China), Chinese staff loyalty to
the enterprise investigation significantly weakened when
compared to 5 years ago, turnover rate has been rising in
geometric level. Over one-third people are seriously
considering leaving, 70% of people whose ages are
between 24 and 29 have considered leaving, top talents
have started looking around for suitable new position.
With the economy and the employment situation
continues to improve, companies are facing the risk of
losing core workers at any time, which brings a big
challenge to enterprise human resource management. This
article analyzes employee turnover behavior from the
perspective of behavioral economics, from the perspective
of non-rational to interpret the turnover phenomenon, so
as to help managers understand employee turnover with
more realistic and reasonable perspective.
II. The Rationality of Employees’ Behavior Analysis from
Perspective of Behavioral Economics
Traditional economic theory suggests that people are
rational and self-interested, seeking to maximize their
interests in the labor market. However, that’s not always
the case in reality, the voluntary leaving of many
employees are not rational decisions, because when
people make decisions, it’s easy to be influenced by those
irrelevant factors such as environment, emotion, family
and other people’s behaviors, their work preferences
would also change.
Theoretical analysis of mainstream economics is
based on the premise of rationality which cannot
effectively explain people’s behaviors, its analysis does
not take into account non-rational decision-making while
behavioral economics is primarily to non-rational
decision-making under uncertainty conditions for the
study, behavioral economics does not negate rational
behavior, but it is to prove the existence of irrational
behavior.[1]
At the core of behavioral economics is the conviction
that increasing the realism of the psychological
underpinnings of economic analysis will improve
economics on its own terms--generating theoretical
insights, making better predictions of field phenomena,
suggesting better policy.[2] In behavioral economics view,
people’s decisions made in their daily life are usually
irrational. Because rational decisions require people
accurately get all the information they need, but that is not
the case, people in reality have no precise and
comprehensive information, nor can they accurately
predict the results. Whereas physiology viewed the body
as a machine, psychology translated this into a perspective
on the mind as a machine.[3] Behavioral economics
combines analysis of people’s economic behaviors
primarily with psychological theory, it combines
psychology and economics, providing more reasonable
and realistic interpretation to those problems that
conventional economics can’t explain.
The study of workers’ irrational decision-making
helps companies better understand their departure which
encourages companies to focus more on their workers’
psychological, emotional, as well as other aspects of the
situation, because usually the employees perform
differently with the result of economics analysis, their
actual behavior in traditional economics seems to be
irrational, for it is not the pursuit of maximum personal
interest. Only four determinants significantly influence
both satisfaction and commitment: routinization, peer
support, supervisor support, and workload. [4] These
irrationalities exist in our life, recognize them and the
employees’ behaviors can help companies know their
employees better, thus better able to carry out staff
management policies, find effective ways to solve the
problem.
behavioral economics, also proposes value function and
weight function. Compared with expected utility theory in
conventional economics, value function replaces the
utility function while weight values replace the
expectations.[5] Value function (as shown in Figure 1)
describes people’s value judgments on economic activity
in risk decision-making, showing that people are always
irrational when evaluating the value of pay and benefits.
Value
III. Behavioral Economics Explanation to Employee
Turnover
Net loss
Behavioral economics analysis of employee turnover
is based on people’s irrational behaviors caused by the
deviation in recognition of the employment market as
well as themselves when they are faced with the risk of
re-employment decision-making. This article analyzes the
problem of employee turnover from three basic theories in
behavioral economics, that is Prospect Theory, Anchoring
Effect and Mental Account Theory.
A. Employee Turnover Analysis Based on the Prospect
Theory
The Prospect Theory is advanced by Kahneman and
Tversky in 1979, which says that people make judgments
and decisions in uncertain conditions are irrational. The
theory contains four basic views, a), certainty effect, i.e.,
people are more willing to receive the existing determined
benefits rather than taking a risk to get a bigger profit; b),
reflection effect, i.e., when the loss is certain, people are
more willing to take a risk; c), loss aversion, i.e.,
decrement in benefit of loss is greater than the increment
in benefit of profit; d), reference dependent, i.e., utility of
income is relative, depending on the level of reference
points.
The Prospect Theory can explain many of the
turnover to some extent, when employees feel that their
value are diminishing at the original post, in other words,
people gradually deviate from the post value of human
resource value, when employees are in a state of loss,
even if the external market is uncertain, which cannot
ensure that you get a better job, they are willing to “a
gamble”, to take risks because they expect the market to
provide a better job. Despite the uncertainty of the
employment market, moreover, new positions may be
worse than the original, employees tend to leave to look
for better job, which is caused by the reflection effect.
In addition, prospect theory can also explain
employee turnover in terms of compensation. Different
from traditional economics analysis of value and benefit
of compensation, prospect theory analyzes people’s
cognitive law of compensation from the perspective of
0
Net profit
Fig.1: Value function
The core idea of prospect theory--that the value
function is kinked at the reference point and loss averse-became useful to economics when Thaler (1980) used it to
explain riskless choices.[6] From the value function, we
can see that people’s evaluation of compensation depends
on the reference point, moreover, compared to profit,
people are more sensitive to loss. This can explain why
the same income does not produce the same effect, which
cannot be interpreted by traditional economics. Increase
in compensation does not necessarily leads to increased
benefit, and in comparable cases, the increased benefit
brought by added absolute value of compensation is
usually lower than the increased psychological effect
arising from relative advantages. Preference theory of
traditional economic suggests that utility is independent
of the reference points, a certain level of income can
always produce a certain level of effectiveness, increased
income will lead to increased effectiveness. It is
confirmed by behavioral economics that people’s
effectiveness depends not only on the absolute value of
their own income, but are also influenced by other
people’s income. Many people quit their jobs because of
the recognition deviation of compensation value, or the
effectiveness doesn’t meet their expectations in
comparison with the reference point. Therefore, in this
case, when enterprises try to retain key employees, it’s
better to raise comparable wages rather than increasing
welfare which cannot be compared, compensation could
and should be given in the form of diversification with
treatment that other companies can’t provide, it’s far more
effective than merely raise wages, and this is the
perspective of behavioral economics.
B. Employee Turnover Analysis Based on the Anchoring
Effect Thoery
Anchoring effect means when people need to do a
quantitative assessment, certain specific values will be
used as the initial value, just like anchor restricts the
estimates. When making decisions, they will
unconsciously set the initial information as part of the
evaluation criteria. Kahneman and Tversky pointed out
that people often pay too much attention to the initial
significant information when making judgment and have
cognitive bias.
Traditional economics theory regards employee
turnover as rational decisions which won’t be interfered
by unrelated factors, and people and always do proper
analysis with correct information which is a rational costbenefit analysis. If the current position cannot meet his
own human resource value, he will choose to leave to find
a new position on the job market that meets or even
exceeds the value of his human resource value. In other
words, if the employee's value matches the position value,
they would stay. However, the reality is not that simple, a
worker’s decision to leave is not only dependent on costbenefit analysis, but also under the influence of many
other factors.
Anchoring effect is a kind of cognitive biases, which
can also explain the irrational resignation. Behavioral
economics suggests that people’s preference is not stable,
different preferences can be induced by different
heuristics. When people make decisions, they tend to be
subject to a prior “Association”, which makes the final
preference of selection bias and reverse.[7] In fact, people
often make decisions under the influence of outside
interference information and their own cognitive biases.
External information such as environment, family, social
relationships and so on will to a large extent, influence
people's decisions, when these factors change, people
would have a re-cognition and evaluation of the current
position as well as its value. On the other hand, a
worker’s self-recognition can also be influenced by other
irrelevant information, other people's words and actions
can influence his decisions to a large extent. In this case,
people leave their job mainly because of the external
information and their own cognitive bias, not out of a
rational analysis result.
C. Employee Turnover Analysis Based on the Mental
Account Theory
In 1980, financial and behavioral economist Richard
Thaler advanced the concept of mental account firstly, he
said that there is a mental account when people making
decisions, they would follow some potential rules of
operation, which are different to those of traditional
economics, these rules differ from traditional economics
significantly regardless of accounting ways and behavior
decisions, thus impact individual decisions unexpectedly,
making individual decisions contrary to the simple laws
of rational economic.[8] In 1984, Kahneman confirm
further that mental account is a process in which people
do the classification, coding, valuation and budgetary
psychologically, it reveals the cognitive process of wealth
decision-making.[9]
Wages in labor markets do not always clear the
market: in many cases, firms pay a higher than marketclearing wage, resulting in involuntary unemployment. [10]
Mental account theory can to a large extent explain the
irrational behavior of employee turnover. Employee
loyalty to the enterprise depends to a large extent on their
psychological contract. Psychological contract will
change with changes in the external environment and their
self-cognition; it is subject to anchoring effect. Job
avoidance represents an early phase of organizational
withdrawal rather than substitutes for exits, as traditional
thinking presumes. Job avoidance facilitates rather than
dissipates the exit-inducing effects of poor attitudes.
Organizations should thus regard excessive absences or
tardiness as signs of impending resignations.[11] When a
worker’s psychological contract to his company can’t
continue, he would have a turnover intention which leads
to resignation.
Mental account influence people’s attitudes and
behaviors by psychological contract, once the violation to
his psychological contract accumulates to the limit of his
mental account, his organizational commitment will
decline and ultimately leads to resignation.[12] The
violation of psychological contract is shown in two
aspects, namely economic account and emotional account.
When an employee's wages, bonuses, benefits, and other
economic benefits changes, his economic accounts will
make an appropriate adjustment; also, if the economic
benefits falls, economic accounts will be reduced, while
psychological contract will also be destroyed, resulting in
turnover. Emotional account mainly records the emotional
interaction between employees and companies, when a
company fails to meet the employees’ emotional needs,
such as paying no attention to their contribution, not
giving reward, lack of learning and growing environment
as well as supportive working conditions, it would
damage the emotional account and psychological contract,
thus force the employees to resign.
Therefore, from the perspective of mental account, a
company should consider the effect of mental account
when designing compensation and the form it is given,
different forms bring about different feelings, and these
feelings would be recorded in the mental account. [13]
When design the payment of compensation and rewards,
companies should take into account the workers’
expectations, adjust their reference point, and reduce the
negative effect caused by the comparison to reference
point. The most effective organizational responses to
employee propensity to quit are those that combine
multiple elements, including family-supportive benefits,
human resource incentives, and work design.[14]
In addition, studies have found that mental account
plays an important role in the incentive because of
emotional experiences in the process of value
judgments.[15]
The
workers’
effectiveness
of
compensation depends more on value judgment in mental
account than other factors, and that can’t be explained by
traditional economics. As a result, behavioral economics
based on the assumption of irrational people can analyze
employees’ effectiveness perception of compensation
more realistically, and proposed a more reasonable
explanation to turnover caused by dissatisfaction with pay.
IV. Summary
This article explains the employee turnover from the
perspective of behavioral economics based on “irrational
people”, different from traditional economics, behavioral
economics studies people’s behaviors in reality combined
with psychology theory. Because in the job market,
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their human resource value and post value. According to
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