5. Payment Schemes Flashcards
Personnel economics
Dealing with the personnel management within firms and thus internal labour economics
What is the aim of payment schemes?
•to maximise output per person per hour whilst also being accepted as equitable by the employees
What does the employment relationship create?
A principal agent problem with moral hazard and adverse selection
How much monitoring will a profit maximising firm do?
They will monitor up until the point where the marginal cost of monitoring is equal to the marginal revenue of monitoring
Piece rate
A screening devise to economise on supervisory personnel in which the work performance of each employee is costly to detect and hence where the employee has occasion to shirk
When are piece rates used more intensively?
•the risk is smaller
•the degree of risk aversion is lower
•the supply elasticity of effort is greater
•in labour jobs
•in larger firms
Benefits of piece rate for employer
Incentive for greater effort, attracts most able individuals and keeps them
Disadvantages of piece rates
•production often depends on team work
•overemphasises the quantity of output produced rather than quality
•salaries could fluctuate over time- firms to compensate workers for this
•ratchet effect- when you perform the task successfully, the employer makes the next task harder for the same payment
Results of auto glass case study
•productivity increased by 44%. 22% of which was due to productivity increase of workers, the rest was explained by sorting effects
•cost per unit fell
Tournament theory
The idea that salaries are pre determined and differences in salaries within a company are on the basis of relative performance rather than absolute performance
What are the main features of tournament theory
•prizes are fixed in advance, independent of absolute performance
•job positions are fixed in advance
•wages that go to managers are pre determined
•the effort exterted by workers to get a promotion depends on the wage increase
What is the equation for expected earnings in a 2 player tournament theory
Expected earnings = Wh(P)+ WL(1-P)- C(U)
How is effort effected in tournament theory when g(0) falls?
Effort falls since luck plays a bigger role in determining the winner
What is the empirical evidence on tournament theory?
There is lots of evidence for tournament theory in firms even though data within firms is hard to find
Why do not all promotions satisfy tournament theory?
•some rewards are relatively small, 2-3% pay rises
•winners are sometimes easy to predict
What is delayed compensation?
Workers are initially paid a wage less than their VMP and later paid more than their VMP in order to discourage shirking
What are the risks of delayed compensation for the worker?
•doesn’t allow for career change
•may be worried about getting fired
•firm may go bankrupt
What do empirical tests for delayed compensation suffer from?
Observing productivity
What does empirical evidence of delayed compensation find?
Senior workers with the same skill level earn more than younger earners
Efficiency wages
Refers to paying a wage above the market rate in order to increase productivity
When should wages be increased until?
Until the MC of increasing the wage is equal to the MB in the workers productivity
Why pay higher wages?
•better nutrition for workers (developing countries)
•inability to monitor worker’s effort- reduces shirking
•attracts highly skilled workers
•builds loyalty among workers
•prevents unions forming
Why do inter industry wage differentials occur?
•in some industries it may be profitable to pay above the competitive wage, while in other industries it isn’t
•these differentials may reflect compensating wages
•could be differences in unobserved characteristics of workers which differ systematically across industries due to a selection bias
Bonding critique
The idea that efficiency wages should self destruct in the LR. If firms use higher wages, workers should be willing to pay an up front performance bond
