This chapter begins the formal analysis of personnel issues by discussing the rules by which firms should make hiring decisions. It is a simple rule, but you should be able to use it and even apply it as in the different scenarios in the text.  The focus on the implications of attributes of the worker, or of the worker’s job, on optimal hiring. Optimal hiring is discussed along several dimensions: what attributes (e.g., what level of quality) of the worker should the firm hire, how many workers should the firm hire (of each type), and how is this related to the firm’s situation, the job, and the wage level.

This and all other chapters begins with a simulated discussion of personnel issues encountered by a group of managers and their firm.  They may seem "goofy" in a classroom setting, but you may encounter these issues.

 I know that it is trivial, but I wanted you to work through it carefully. It reminds you that personnel decisions can use analytical can be illustrated the fundamental concept of economics: tradeoffs (costs and benefits).  How many times have you heard a manager or student assert that their organization needs to hire the "best possible workers"?  Now you know that is not the best method.

•  First, there are lessons about the methodology of economics.

•  Second, there are implications of worker characteristics (quality and riskiness) for hiring.

•  Third, there are implications of firm, labor market, and job characteristics for hiring.

1) Personnel decisions and design of personnel policies involve tradeoffs, or the balancing of specific benefits with costs. The optimal decision or policy rarely maximizes one objective (e.g., quality of the workforce). The intuition of thinking in terms of tradeoffs is fundamental to personnel economics.

2) Personnel economics emphasizes the use of models, or simplifications of complex reality. Models are necessary in order to simplify, make sense of, and generalize from complicated situations. All scientific disciplines use models in analysis; economics is just more formal and rigorous about modeling than are other social sciences. Models also provide discipline for your thinking: they force you to focus on crucial issues.

3) Personnel decisions and policy design are likely to be better when the manager or firm use quantitative estimates of the relevant numbers or do experiments rather than simply using intuition.

4) Firms should not hire the "best workers". Hiring involves a tradeoff of costs and benefits; the right approach is to hire those with the lowest ratio of salary to output.

5) Empirically, education and work experience are the two most important predictors of a worker’s quality.

6) The firm should continue hiring workers as long as the increment to profit brought about by hiring the worker is positive.

7) Which workers the firm should hire depends on the costs and benefits of the workers, not the financial condition of the firm.

8) Interdependence in production also affects the hiring decision:

• When workers interact on the job, a worker’s contribution to output includes the effects of his or her co-worker’s output. It pays to hire more and better workers when output is interrelated.

• As the firm increases the amount or quality of its capital stock, it should improve the quality of the workers that it employs (the optimal skill level rises as the capital/labor ratio rises).

9) It usually pays to hire a riskier worker because the firm has an option value. If the worker does not succeed, he or she can be fired, reducing the potential cost. If the worker does succeed, the benefits can be enjoyed over the entire career.

• The younger the worker or the shorter the time required to learn the worker’s productivity, the greater the value of a risky worker.

Questions to think about  (May get rewritten into an essay question for the test)

When interviewing for a job, the recruiter tells you that the firm only wants to hire "The Best and the Brightest"? Evaluate this claim. Does it make sense? If so, under what circumstances?

Consider your last job. What attributes were important in determining productivity on the job? Which of these attributes were possessed by new hires, and which were developed only after you were on the job for a while?  Which of these attributes could your firm actually evaluate reasonably well when looking at job candidates? How did they do this? Which attributes would be quantifiable? How? Would this job be a good candidate for experimentation as outlined at the end of Chapter 2?

Chapter 2

The last chapter was about how to set the standards for hiring; this chapter is about how to use personnel policies to achieve those standards. For the first time in the text, the firm’s personnel policies come to the forefront. The main conceptual idea in the last chapter was how to think in terms of tradeoffs (and how to model workers as having simple productive characteristics). Here, the main idea is adverse selection: if workers have private information about their characteristics, than this can often lead to undesirable hiring effects if the firm is not careful.

The idea of worker self-selection is the organizing concept for thinking about design of personnel policies in this chapter. A central point is that well-designed policies must take into account the strategic self-interested responses of applicants and employees. Sometimes this self-selection must be mitigated by careful policy design; sometimes it can be exploited to better achieve the firm’s personnel goals.

Most of the chapter is a coherent block that works as a single unit, focusing on policies designed to find or attract the right type of workers. However, it ends with two short applications of sorting and adverse selection that are related to the rest of the chapter more in concepts than in personnel policies: labor market outcomes for men v. women, and self-selection of workers when offered retirement buyouts.   We used the chapter to introduce the economics of efficiency and compare Pareto Efficient outcomes to those that would be selected by individual with different payment schemes. to Cover

1) When job applicants or employees have better information about their abilities than the firm does, the firm faces a potential problem of adverse (self) selection: the wrong kinds of workers may be attracted to the position. Often, this manifests itself as too low quality workers attracted to a job.

2) Another example of adverse selection is in the opposite of hiring: retirements. Higher ability workers generally have better outside alternatives, and thus are more likely to accept an early retirement offer. Any blanket retirement policy offered to all employees will exhibit this; firms must carefully management retirement buyouts to avoid the problem.

3) The firm should design personnel policies to mitigate adverse selection in hiring; in some cases it may exploit employee self-selection to achieve better job matches. There are three general policy approaches the firm can use: credentials, contingent compensation, and pay for performance.

4) Credentials attempt to mitigate self-selection by sorting workers before they are hired. They are effective only if they meet the requirements of the economic theory of signalling or screening:

n The credential must be correlated with job performance.

n Obtaining the credential is relatively easy for well-qualified workers, but very difficult for poorly qualified workers.

5) Education is probably the most important credential used in the labor market.

n If the difference in earnings between the educated and less educated workers is not very great, small differences in educational attainment will signal large differences in ability. This is because the returns to the credential are small, so it must be relatively easy for high ability workers to obtain the signal for them to be willing to do so.

6) Contingent contracts attempt to exploit self-selection by making compensation contingent on performance. Those with high ability earn sufficiently high pay, and those with low ability earn sufficiently low pay, that high ability workers have incentives to apply for the job but low ability workers do not.

7) One common form of contingent contracts is probationary periods.

8) Pay for performance ("piece rates") is similar conceptually to probationary periods.

n Piece rate jobs generally attract higher quality workers than those with straight salary, but the firms that pay piece rates pay higher average wages and may bear greater monitoring costs.

Questions to think about

What conditions are necessary for the firm to face a problem of self selection by the wrong types of workers in applying for a job?

Consider the education and degree you are now earning. Is it a credential? Why or why not? For what kind of job is it most likely to serve as a valuable credential?

Chapter 6

This chapter presents the classic analysis of human capital and training. Because the view of the worker’s skills is dynamic in this model, this is new conceptual territory compared to earlier chapters. The chapter has five basic parts.  The first introduces the concept of human capital through an extended analysis of optimal schooling decisions. The second and third cover general human capital (who will pay for the investment, and whether the firm or the worker should decide the amount of the investment). The fourth and fifth cover these questions for firm-specific human capital.

1) Investments in skills through education or on-the-job training may be viewed as an investment (with current costs and future benefits) by the worker or firm (or both):

n Increases in costs reduce the optimal investment (e.g., tuition, training costs).

n The costs of education include tuition and foregone earnings while in school. The costs of on-the-job training include lost productivity from not working regularly during the training.

n Those with good alternatives (e.g., potential students with good jobs) will tend to invest less in training because the returns will be lower.

n Those with higher ability will tend to make greater investments in the training, because the returns will be higher.

n The longer the work life, the more the optimal investment in schooling or training.

n Educational investments will tend to be made when the person is younger.

n On-the-job training will tend to be more important for younger employees.

n Those who expect to spend more time out of the workforce or job (e.g., those who plan to take extended parental leave) will optimally invest less in the training.

n Training will imply increasing age-earnings profiles for workers. This is because the worker’s skills increase over time, and his or her time spent investing in training decreases over time so there is more time to perform the work.

n Age-earnings profiles also tend to be convex. The chief reason is that training has diminishing marginal returns. The second reason is again that the worker will spend less time acquiring skills over time.

2) An important distinction in on-the-job training is between general and firmspecific human capital:

n General training increases the worker’s productivity equally at the current firm and some other firms.

n Firm-specific training only increases the worker’s productivity at the current firm.

3) General training increases the worker’s market value outside the firm, so the firm must pay the worker more after the training in order to retain them.

n For this reason, the worker receives all of the benefits of the training. Thus, the firm will be unwilling to pay any of the costs of the training; it will require reduced wages during the training period that reflect lower productivity. If the investment is worthwhile, the worker will be willing to accept the lower initial wages, and thus the worker will also pay the costs of the training.

n Because of this, the firm is indifferent between training and not training the worker when training is purely general. The worker should decide whether or not to undergo the training.

4) Firm-specific training does not increase the worker’s market value outside the firm, but does increase his or her value inside the firm. Therefore, the firm does not have to pay higher wages to retain the worker. However, the worker can threaten to quit if not paid more than his or her market value. The "quasi-rent" created by a firm-specific human capital investment has several important implications:

n The potential for hold-up causes both the firm and the worker to be unwilling to make the full investment themselves in the hopes of reaping all of the benefits.

n Some splitting of both the costs and benefits gives both sides incentives to (1) make the investment; (2) maintain the employment relationship to recoup the benefits.

n The result is a positively-sloped age-earnings profile similar to that occurring when there is an investment in general human capital.

n If the costs and benefits are shared, the worker will usually make optimal decisions about whether or not to undergo the investment in firm-specific training. The only qualification is that uncertainty about the length of the worker’s tenure at the firm is uncertain; for this reason the firm will tend to take a more active role in determining who is given such training.

n Perhaps the most important implication of firm-specific human capital is that turnover should be lower: there is economic value to maintaining the worker’s employment at the present firm.

Questions

Many part-time or evening MBA students have their tuition paid for by their employer. Is an MBA education firm-specific or general training? Given your answer, how do you explain this practice? What arrangements or contractual terms do you predict that such firms will try to impose in these cases?

A dean at Stanford Business School recently claimed that business schools face a very serious competitive threat—corporate in-house training programs designed to substitute for MBAs. Do you think this is a serious threat? Why or why not? What kinds of companies do you predict are more likely to run such programs? What kinds of topics do you predict they will tend to teach?

Many older workers appear to earn wages much higher than the value of their productivity (such workers are often called "deadwood"). Does this make sense from the perspective of human capital theory? Why or why not? What other explanations can you think of?

If an individual believes that he or she will face labor market discrimination during their career, what effect do you predict that this will have on their incentives to acquire education? On-the-job training? For the latter, is your answer different if the training is general or firm-specific?

Chpt 4

Chapter 3 focused on the case in which the potential employee has private information about his or her abilities. There are two other possibilities; the firm may have private information about the employee’s abilities (since the firm knows the job characteristics better), or there may be "symmetric ignorance" about the worker-firm match. It is the latter case that is the focus of Chapter 4. Therefore, this is a direct extension of the concepts of Chapter 3 and Chapter 6.

The main focus of the chapter is on screening. Thus, there is little sense of opportunistic behavior by workers (as in Chapter 3) or the firm since ignorance is taken to be symmetric. Instead, the chapter is about investing in valuable information about the worker’s ability. In this sense, the topic is very similar to the discussion of investment in human capital (especially firm-specific) in Chapter 6. If the productivity being screened is a firm-specific job match, then we might simply view it as a form of firm-specific human capital.

Points to Cover

1) There are three logical possibilities for information about an employee’s ability to be productive on the job: the worker has private information as in Chapter 3, the firm has private information because it knows the job best, or there is symmetric ignorance.

2) Better information about a worker’s abilities has economic value: the worker is given more productive job assignments or placed in a firm where he or she can be more productive. But it may be costly to develop this information (through testing or on the job observation).

3) Therefore, sometimes it may pay for the firm and/or worker to invest in this information through screening. This investment perspective is very similar to the economic model of investments in human capital in Chapter 6.

n If screening is a worthwhile investment, workers are willing to apply to a firm that screens because it can hire more able workers and pay them more as a result.

4) Just as with human capital investments,

n If the information about worker productivity can be kept within (specific to) the firm, then the firm is willing to make the investment and reap the rewards through higher employee productivity.

n If the information about worker productivity will become public, the worker is willing to make the investment (through lower initial wages) and reap the rewards (through higher eventual wages). An important example of this is the public nature of job title changes that accompany promotions and other job reassignments.

n The ultimate sharing of the costs and surplus depends on the relative bargaining power of the firm and worker.

5) Screening of applicants is more profitable when:

n Screening costs are small.

n A larger proportion of applicants is refused employment because of the screening.

n Employing those targeted (weeded out) by screening would be costly to the firm.