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II. Human Resource Management

OTTO-VON-GUERICKE-UNIVERSITY MAGDEBUR G BEIJING NORMAL UNIVERSITY. Prof. Dr. Birgitta Wolff, Marjaana Rehu, M.A. Otto-von-Guericke-University, Germany. II. Human Resource Management. Variable or Fixed Salary. Recap Session I. „... three critical aspects of organization:

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II. Human Resource Management

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  1. OTTO-VON-GUERICKE-UNIVERSITY MAGDEBURG BEIJING NORMAL UNIVERSITY Prof. Dr. Birgitta Wolff, Marjaana Rehu, M.A. Otto-von-Guericke-University, Germany II. Human Resource Management Variable or Fixed Salary Beijing, Sept. 2002

  2. Recap Session I • „... three critical aspects of organization: • The assignment of decision rights within the company • The methods of rewarding individuals • The structure of systems to evaluate the performance of both individuals and business units“ • (BSZ 5) Beijing, Sept. 2002

  3. Outline 1. Incentive Problem 2.Compensation Contracts 3.Output-Based Pay 4. Input-Based Pay 5. Incentive Pay Source: www.msn.de Beijing, Sept. 2002

  4. 1. Incentive Problem Coordination and Motivation Problem Task Coordination Who does what, when,... Motivation How do I get somebody to perfom a task,improve the quality,... => Incentive Problem Allocation of Input Resources Distribution of Output Individual Source: Wolff/Lazear (2001): Einführung in die Personalökonomik, Stuttgart: Schäffer-Poeschel, S. 51 Beijing, Sept. 2002

  5. 1. Incentive Problem Why do Incentive Problems Exist? • Why do Incentive problems exist? • Employee and employer have different interests • Employer would want the employee to take actions that maximize the profit of the firms, but the employee might rather like spending his time with his/her family or play golf • All actions of the employee cannot be monitored and/or controlled by contracts (risk for the employer) • Employers have to compensate employees for doing undesirable tasks Beijing, Sept. 2002

  6. 1. Incentive ProblemHow can Incentive Problems be Solved? • Incentive Problems can be solved through effective compensation contracts • Compensation contracts have two functions • Motivate employees • Share risk more efficiently Source: www.euro.fi Beijing, Sept. 2002

  7. 2. Compensation Contracts Compensation Contracts Variable Pay Fixed Salary Payment by Output Payment by Input Subjective Performance Measures Subjective Performance Measures Objective Performance Measures Objective Performance Measures Beijing, Sept. 2002

  8. 2. Compensation Contracts Payment by Input versus Payment by Output Variable Pay (payment by output) Straight Salary (payment by input) • Compensation depends on measure of what comes out • Amount of time spent on work does not affect workers‘ compensation • Problem:  Output not always easy to measure • Compensation depends on the amount of time or effort spent on an activity • Independent of output consideration • Problem:  Input also not always easy to measure • Time at work as a proxy in order to assess worker‘s effort Examples: Examples: • Wage per work hour • Monthly salaries • Annual salaries • Agricultural workers: piece rates p. tray • A salesperson on straight commission • Compensation of top executives by stocks or stock options Beijing, Sept. 2002

  9. 2. Compensation ContractsHow can the Performance of an Employee be Measured? • Objective Performance Measure: • Measure that is easily observable and quantifiable, e.g. parts produced, hours worked etc. • Subjective Performance Measures: • An evaluation which is based on personal opinion of a supervisor, customer, peers, etc. Beijing, Sept. 2002

  10. 2. Compensation Contracts Examples of Different Variables as a Basis of Output-Related Pay Beijing, Sept. 2002

  11. 3. Output-Based Pay Advantages of output-based pay Selection effect Motivation effect • efficient workers with a high productivity will join the firm/stay • inefficient workers with a low productivity will not join/leave the firm • output-based pay motivates workers to put forth more effort Source: www.kone.fi Beijing, Sept. 2002

  12. 3. Output-Based Pay Selection Effect: An Example of Compensating Salespeople Beijing, Sept. 2002

  13. 3. Output-Based Pay Selection Effect: An Example of Compensating Salespeople (cont.) W ...Weekly Pay A (World Book) 500 B (Britannica) 300 3 5 x ... Number of encyclopedia  Higher-productivity workers will leave Britannica, because they will earn more at World Book. Only lower-productivity workers will stay at Britannica Beijing, Sept. 2002

  14. 3. Output-Based Pay Disadvantages of Output-Based Pay • Disadvantage of piecework: Variations of output can be beyond the worker‘s control Straight salary Variable pay • Variable pay depends on invested effort and exogenous risks – risky form of compensation •  Firm should smooth out exogenous risks from workers‘ compensation • Firm should bear exogenous risks but endogenous risks should remain with workers • Trade-off: More riskhigher compensation • Opportunity: participate in good economic development • Stronger incentives • Fixed salary doesn‘t depend on exoge- nous factors – low-risk form of compensation •  Workers are insured against volatilities •  Firm provides the insurance for risks • Lower compensation level • Can not participate in good economic • development • Weaker incentives Beijing, Sept. 2002

  15. 3. Output-Based PayRisk in Output-Based Pay • The firm should bear the largest portion of risk because of risk pooling abilities • Workers with a high average compensation should bear more risks than workers with a low average compensation. Source: www.kone.fi Beijing, Sept. 2002

  16. 4. Input-Based Pay • In spite of all the advantages of output-based schemes: A large proportion of workforce is paid by input • Compensation depends on the amount of time or effort spent on an activity • Independent of output consideration •  Time at work as a proxy to assess worker‘s effort Source: www.euro.fi Examples: wage per work hour, monthly salaries, annual salaries Beijing, Sept. 2002

  17. 4. Input-Based PayBenefits of Input-Based Pay Problems of output-based pay solved by time-based (input-based) pay • Finding the right output measure • Costs of measurement • Overemphasizing quantity, reduction of quality • Risk aversion of workers • Promoting long-run performance However, in many cases output-based schemes could be used if only they were designed correctly! Beijing, Sept. 2002

  18. Compensation Schemes Balancing Quantity and Quality • Piece rates could induce workers to focus on high numbers of low quality products meeting only the sufficient quality level to ‚count‘ •  Appropriate compensation schemes could solve this problem Example: Typist‘s compensation Beijing, Sept. 2002

  19. 4. Input-Based Pay Using the Appropriate Time Unit Input-based pay Hourly wages Monthly salary Annual salary • Production workers • Clerical workers • Managerial workers • Top Management Tasks: not experienced and difficult to prescribe; often to be defined by top manager Tasks: less experienced and not easy to prescribe Tasks: experienced and easy to prescribe • Low correlation between effort and work time • Time input = bad measure for effort  overinvestment in easy (pleasant) tasks • High correlation between effort and time invested • Time input as a pretty good indicator for effort • Undefined set of tasks (goal), discretion over work • Importance of other incen- tives to motivate for effort (long-term, e.g. stock options) Beijing, Sept. 2002

  20. 5. Incentive PayOptimal Level of Variable Pay • Since employees do not diversify their risk • Large exogenous risks should be born by owners Fixed salary • However, employees are motivated by pay for performance Variable Pay Part of the pay should be fixed and part variable Beijing, Sept. 2002

  21. 5. Incentive Pay Forms of Incentive Pay • Rewards do not need to be monetary, they can consist of anything that employees value • E.g • Piece rates and commissions • Bonuses • Parking spots • Days off • Promotion • Training • Stock ownership • Health care plan • Housing • Education for kids • Retirement Plan • Party Beijing, Sept. 2002

  22. 5. Incentive Pay Criticism to Incentive Compensation • Often heard critics to incentive compensation: • Money does not motivate • It is difficult to design effective incentive schemes • Incentives certainly entail costs • The major problem is to design incentive schemes where the benefits exceed the costs Beijing, Sept. 2002

  23. Furter Readings Brickley, J. A./Smith, C. W. Jr./Zimmerman, J. L. (2001): Organizational Architecture, 2nd ed., Irwin Book Team. Lazear, E. P. (1998): Personnel Economics for Managers, New York (John Wiley & Sons) Beijing, Sept. 2002

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