Labor Markets

1

• Labor Markets
• Attracting and Retaining Qualified Employees
• Chapter 14
• Incentive Compensation
• Safelite (A)

2
Perfectly competitive labor market (Benchmark
model )of employment and compensation

• Assumptions
• competitive labor market
• wages determined by supply and demand
• current market wages costless to determine
• all jobs identical
• no long-term contracts
• all labor hired in spot market
• all compensation is monetary

3
Value of labor

• Compute MP of each checkout person (lane)
• If revenue net of cost of goods per customer is
  25, compute MRP (marginal revenue product)
  the revenue each new checkout lane brings in
• If wage is 30, how many lanes to open?

4
Demand for labor in benchmark model

• MRP MP x P
• Each firm hires to point where
• MRPmarket wage
• Labor demand satisfies this equality
• Labor earns its marginal (revenue) product
• The Labor Theory of Value (Marx) is completely
  false.

Productivity growth raises workers MRP, which
raises workers wages.
5
Managerial implications

• If you pay less than market wage, cant fill
  positions
• If you pay more than market wage, youre at a
  cost disadvantage

6
Perfectly Competitive Modelwage determination
7
Relaxing the benchmark assumptions

• All jobs are not identical
• employees will choose most desirable job for
  given level of pay
• firms must offer compensation for undesirable
  characteristics (compensating differential)
• Workers are not perfect substitutes
• Information is costly
• Compensation takes many forms
• Jobs may be long term

8
Human Capital

• Specific Vs General
• Decision to invest depends on Net Present Value
  of costs and benefits
• Firms have little incentive to invest in general
  and employees have little incentive to invest if
  firm specific
• Usually increase with tenure gt Wages usually
  increase with tenure
• Education can be a screening device

9
Average Annual earnings by Educational Attainment
10

• Labor Market Turnover
• Costly to both employees and firms
• Loss of specific human capital
• Hiring costs - search and training
• Most separations come from workers with little
  tenure
• Match Capital - Incomplete information when
  someone is hired, Good matches are more likely to
  survive.

11
Internal Labor Markets

• Some non-entry jobs may be filled by individuals
  from within the organization
• This is the internal labor market
• Long-term relationships with employees
• Often governed by implicit contracts informal
  understandings
• Increase investment in Human Capital
• Help to generate Match Capital

12
Long term employment

• Compensation typically rises with seniority
• higher productivity (MRP)
• Maybe compensation rises faster than productivity
  (MRP) -
• incentive to work in best interest of firm,
  acquire firm-specific human capital
• Risky for employees is the firm viable?

13
Upward sloping earnings profile
Bad Cops, Bad Cops Or Good Cops? Why do Cops
receive relatively generous retirement pay?
14
Compensation componentssalary plus benefits

• Salary and benefit compensation are not perfect
  substitutes for employees
• the role of taxes
• groups may purchase benefits at lower price
• Benefits inflexible salary flexible (in use)
• Employees may wish to trade between salary and
  benefits to attain optimum combination

15
Benefits in U.S.

• Employee Benefits 29.2 of Total Comp.
• Among Large Employers, 1993
• Legally required payments (SSI, etc.)
• Retirement
• Insurance
• Paid Rest, vacations, sick leave, etc.
• Miscellaneous (perks, etc.) 
• Source U.S. Chamber of Commerce, Employee
  Benefits 1993

16
Optimal mix between salary and benefits
17
Optimal choice of salary and benefits with taxes
With less than two months until the end of the
year -- traditional bonus paying time --
executives at the securities firms and recruiters
who work with them predict bonuses will increase
by an average of 10 to 20 compared with a year
earlier. Though that likely will still leave them
far below the go-go times of a few years ago, it
could nonetheless mark a turning point in
fortunes for the battered securities industry.
18
Risk and incentive compensation

• Factors outside employees control
• Risk aversion
• gt incentive pay contracts must balance
  motivation vs. risk bearing
• Examples
• CEO performance bonuses, stock options
• Professors 1700s universities gave fees to
  professors for attracting more students
• Weather forecasters Kursk, USSR bonuses tied
  to of accurate forecasts
• Columbus Spain monarchy entitled him to 10 of
  all gold, gems, tax free
• Salespeople paid on commission
• Lincoln Electric and Safelite

19
Basic principal-agent model

• Effort not directly observable use proxy
• post contractual asymmetric information
• Outside risk factor
• Could work hard but not all measured
• gt Compensation contract
• tie incentive pay to proxy to motivate effort
• Include base pay to reduce risk bearing

20
Basic principal-agent modelRisk

• If replace some base pay with variable
  compensation
• More variability in pay increased risk
• Must give higher expected compensation
  (compensating differential)

21
(No Transcript)
22
Safelite Glass

• 600 small auto-glass repair centers
• 1994 pay for performance introduced
• Hourly wages f(base salary, glass installed)
• Minimum base salary 11/hr
• Must install defectives without pay
• Benefits TBA
• Costs TBA
• Net effect TBA
• Source E. Lazear, Performance Pay and
  Productivity, The American Economic Review, Dec.
  2000

23
Safelite Glass

• Why was the productivity of Safelite installers
  so low?
• What is PPP trying to accomplish?
• What are the likely consequences of a switch from
  wage rates to piece rates for
• Turnover
• Recruitment
• Productivity
• Product Quality
• Total Labor Costs
• (How) will PPP succeed?
• What are the potential pitfalls in PPP?
• Should management proceed with the introduction
  of PPP or even a modified PPP?

24
Looking Forward

• November 29,30 and December 2
• Incentive Compensation
• Chapters 15
• Case Readings Safelite (B)
• Course project presentations and discussions
• December 6, 7, and 9
• Performance Evaluation
• Chapters 16 and 17, Arthur Anderson
• Final Project Due
• December 13, 14, and 16
• Final Exam