LABOR AS A QUASI-FIXED FACTOR: Effect of Turnover on Employment Relationship
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LABOR AS A QUASI-FIXED FACTOR: Effect of Turnover on Employment Relationship I. Turnover from 2 perspectives II. Efficiency Wages as solution to turnover. FIRM’S VIEW Replacement Costs Loss of investment. WORKER’S VIEW Direct Current Costs Indirect Current Costs

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LABOR AS A QUASI-FIXED FACTOR: Effect of Turnover on Employment RelationshipI. Turnover from 2 perspectives II. Efficiency Wages as solution to turnover


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FIRM’S VIEW Employment Relationship

Replacement Costs

Loss of investment

WORKER’S VIEW

Direct Current Costs

Indirect Current Costs

Expected Future (may be soon) Benefit

2 SIDES TO VOLUNTARY TURNOVER

Turnover is a cost

Turnover is an investment


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Worker Perspective:Turnover as Human Capital Investment Employment Relationship

  • Same framework as with education:

    • PVB =S [(B1 - B2 )/(1+r)t]

      • Where: B1 are the benefits associated with leaving current job

      • B2 are the benefits associated with staying in current job

      • t is length of time expected to be in new job and r is discount rate

    • Leave if PVB => C

      • C are the direct costs associated with t.o. borne by the employee


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YOU TELL ME: Employment RelationshipWHO IS MORE LIKELY TO VOLUNTARILY LEAVE?

  • Males or Females

  • Minority or Non-Minority

  • Older or Younger

  • More Educated or Less Educated

  • Up or down swing of Business Cycle

  • More Job Tenure or Less

  • Urban or Rural

  • Large or small firm


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Employer Perspective: Replacement Costs Employment Relationship

  • Incoming employees: takes 13.5 mo. to reach 100% efficiency

  • Co-Worker time: b/n 8% and 14% of workday helping new employee

  • Departing employee: 1 mo. lost prod.

  • Co-worker slack off

  • Vacancy period: 13 wks.


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Estimates of Replacement Costs Employment Relationship

  • HR Manager Auto Manu. $133,803

  • Salaried Journeyman machinist: $102,796

  • Hourly Journeyman machinist: $58,732

  • Technical Project Leader Software Co: $32,215

  • Systems Engineer Software Co: $34,397

  • Fast Food Chain Store Manager: $21,931

  • Kitchen or Counter Person Fast Food: $1,521

    Source: “Losses Mount in Fight against Turnover,” Bulletin to Management, 50(24), June 17, 1999, p. 185.


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Joint Problem with Turnover: Loss of Human Capital Investment

  • Loss to Individuals:

    • Loss of Firm Specific Human Capital Investment

  • Loss to Firms

    • Loss of both Firm Specific and General Human Capital Investments


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EFFICIENCY WAGES: InvestmentEarnings Schedule As Way To Reduce Turnover


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“Typical” Earnings Schedule revisited Investment

Then flatten out later in career

Earnings

Earnings rise quickly early in career

Time


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TWO PUZZLES ABOUT EARNINGS Investment

  • Why do earnings increase with work experience?

  • Why do some firms appear to be paying above-market wages?

    Answer: Firms are engaging in an

EFFICIENCY WAGE STRATEGY


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EXPLANATIONS FOR WHY EFFICIENCY WAGE STRATEGY Investment

4 Explanations

1) Reduce Shirking

2) Raise Morale

3) Improve Job Applicant Quality

4) Lower Turnover


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BASIC EFFICIENCY WAGE MODEL Investment

  • Competitive Product Market

  • Firm production function:

    • Q = f(e(w)n)

      • where e is effort per worker, w is wage, & n is number of workers

People respond to greater wages with

greater effort


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Intuition of Efficiency Wages Investment

People respond to greater wages with greater effort

Shows that paying above market may be economically rational

Also provides basis for increase in earnings over time


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Why Earnings Increase over time: InvestmentMONITORING AND REDUCING TURNOVER

  • 2 Types of Compensation

    • Time - Based

      • Reward or pay according to # hours or days or weeks

    • Output - Based

      • Reward or pay according to output (e.g., piece rate, commissions, profit-sharing)


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ERs Prefer Output based Investment

Tight link b/n pay & Productivity

Efficiency condition: MPL=W

Workers bear risk of uneven prod.

Attract most productive

Minimal monitoring

Workers Prefer Time-based

Need for stable income (variable earnings but constant expenses)

EMPLOYER & WORKER PREFERENCE


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Piece-Work Investment

Product Quality

Misuse of equipment

Rate setting

Measuring output

Group Production

Free Rider

Complex output

Time-based

Shirking

Monitoring (the Agency Problem)

Each Type Poses Problems for Employers

Most Pay is Time Based


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Efficiency Wage Solution to Time-Based Pay Investment

  • Take advantage of fact that work takes place in contractual environment

  • Features of contractual environment

    • 2 Parties agree to exchange

    • Two types of contracts

      • Explicit

      • Implicit


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Implicit vs Explicit Investment

  • Explicit contracts

    • Have specific provisions

    • Enforceable by 3rd party

  • Implicit: Self-Enforcing Contract

    • Def.: where in both parties’ self-interest to abide by contract

    • Contract generates surplus (get more from contract than next best alternative)


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Worker Objectives Investment

Risk-Averse

Reward => Contract renewal

Firm must eventually pay more than can earn elsewhere

Source of surplus: Earning more than next best alternative

Firm Objectives

Maximum productivity at lowest monitoring costs

Source of Surplus: PV of profits from worker’s efforts > can get from firing worker

Self-Enforcing Contract in workplace


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EARNINGS SCHEDULE AS SELF-ENFORCING CONTRACT Investment

  • CASE 1: FLAT EARNINGS

    • Workers get same (market) wage in each period

    • Analysis:

      • No Disincentive for Worker Cheating: No Benefit to Worker to Renew Contract

      • No Incentive to Firm to Keep Worker: If paying MPL, can just hire different worker

      • Reason we don’t see flat earnings in L-T employment relationship


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CASE 1: Flat earnings Investment

Wage

Market Wage

Time


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EARNINGS SCHEDULE AS SELF-ENFORCING CONTRACT, CONT Investment.

  • CASE 2:FLAT EARNINGS TURNING UP AT END

    • Workers receive W (=MPL) for all periods until last

    • Pay a Bonus to get worker not to shirk in last period

      • Size of bonus depends on:

        • Benefit of not putting forth effort

        • Probability of getting caught


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EARNINGS SCHEDULE AS SELF-ENFORCING CONTRACT, CONT. Investment

  • CASE 2, CONT:

    • Analysis:

      • Shirking problem: Prevent workers from cheating by paying more than alternative in last period

      • But, violates efficiency condition: Firm must still meet efficiency condition (PVPL = PVCL), but would have to pay W < MPL.

        • Firm can still cheat and has incentive to do so.

      • Rare in long-term employment relationship


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Case 2: Bonus in last period Investment

Market Wage

Wage

Time


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EARNINGS SCHEDULE AS SELF-ENFORCING CONTRACT, CONT. Investment

  • CASE 3: LOW START, FLAT IN MIDDLE, HIGH AT END

    • Entrance Fee: Way for firms to meet efficiency condition over employ. rel.

    • Analysis:

      • Both parties need surplus since both can cheat (firm can fire; worker can shirk)

      • Bonus must outweigh entrance fee & benefit of shirking; Worker must believe firm will pay


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Case 3: Upward Sloping Wages Investment

Wage

Time


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Case 3: Upward Sloping Wages, Smoothed Investment

Wage

Wage

Marginal Product

Time


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EARNINGS SCHEDULE AS SELF-ENFORCING CONTRACT, CONT Investment.

  • UPWARD SLOPING WAGE PROFILE

    • Looks like typical earnings function

  • PUZZLE: How to get people to leave at end of bonus: Mandatory retirement (What I think your biggest problem is going to be)


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EARNINGS SCHEDULE AS SELF-ENFORCING CONTRACT SOLUTION Investment

  • ILM & Market Coincide

  • Increasing earnings over time = alternative to close supervision under time-based compensation

    • Pay workers more than best alternative

    • Offer rewards after years of diligent effort

    • Long-term relationship allows monitor


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ILM AS SELF-ENFORCING CONTRACT SOLUTION, Cont Investment

  • Workers Choose firm based on PV of lifetime earnings not entry wage

  • Nature of Contract

    • Long-term relationship

    • Job security and sustained effort

  • Features of ILM that solve monitoring

    • Resource control after long tenure

    • Job complexity