Transcript ASSIGNMENT OF TASKS, REWARD SYSTEMS, AND PERFORMANCE EVALUATION TWELFTH LECTURE

ASSIGNMENT OF TASKS,
REWARD SYSTEMS, AND
PERFORMANCE EVALUATION
TWELFTH LECTURE
April 24, 2012
William R. Eadington, Ph.D.
Professor of Economics, College of Business
Director, Institute for the Study of Gambling and Commercial Gaming
University of Nevada, Reno
www.unr.edu/gaming
http://www.cbs.com/shows/60_minutes/vid
eo/2215193382/resurrecting-chryslerevidence-of-innocence-novak-djokovic
SPECIALIZED TASK
ASSIGNMENT
• Benefits
– comparative advantage
– lower cross-training expense
• Costs
– foregone complementarities across
tasks
– coordination costs
– functional myopia
– reduced flexibility
METHODS OF GROUPING JOBS
• Unitary form of organization
– group by functional specialty
– each primary function in one major
subunit
FUNCTIONAL
ORGANIZATION
Chief Executive Officer
Sales Department
Service Department
FUNCTIONAL SUBUNITS
• Advantages
– promotes effective coordination
– promotes functional expertise
– well-defined promotion path
• Disadvantages
– opportunity cost of senior management time
– coordination problems across departments
– employee focus on functions, not customers
(“Not my job” syndrome)
FUNCTIONAL SUBUNITS
• Tend to work best
– in small firms with homogeneous products
– when technological change is slow
METHODS OF GROUPING JOBS
• Multidivisional form of organization
– group by product
– group by geographic area
– each unit has multiple functions
PRODUCT AND GEOGRAPHIC
ORGANIZATION
(One or the Other)
Product Organization
Geographic Organization
Chief Executive Officer
Chief Executive Officer
Business Products
Division
Consumer Products
Division
West Coast
Division
East Coast
Division
Sales Department
Sales Department
Sales Department
Sales Department
Service Department
Service Department
Service Department
Service Department
PRODUCT/GEOGRAPHIC
SUBUNITS
• Advantages
– decision rights tied to specific knowledge
– senior management able to focus on
strategy
– promotes coordination pertinent to
product/area
• Disadvantages
– unit interdependencies may be ignored
– economies of scale or scope may be
foregone
METHODS OF GROUPING JOBS
• Matrix organization
– intersecting lines of authority
– functional departments address
performance reviews and professional
development
– product/geographic subunits address
customer/client needs
MATRIX ORGANIZATION
Chief Executive Officer
Sales Division
Service Division
Business Products Team
Business Sales
Department
Business Service
Department
Business Products Team
Consumer Sales
Department
Consumer Service
Department
MATRIX ORGANIZATION
• Difficult to implement
• Ambiguity in chain of command => reporting
to more than one boss
• Incentives for cooperation are not strong
• Other structures:
– mixed design
• organize by product, geography and function depending
on the subunit
– Network
– Keiretsu
EXAMPLE: IBM CREDIT
• Originally organized around functions
– employees assigned specialized set of
tasks within functional area
– employees had limited decision authority
• Credit application processing took six
days as each functional area reviewed
the application
– Files would be passed from desk to desk
in application process
IBM CREDIT WITH FUNCTIONAL
ORGANIZATION
General Manager
Credit
Department
Contracts
Department
Pricing
Department
Documents
Department
A “RE-ENGINEERED” IBM
CREDIT
• New technology and information
systems supported task reassignment
and job redesign
• Caseworkers would cover each of the
functional areas: credit, contracts,
pricing, documents
• As reorganized, empowered
caseworkers handle process in 4 hours
IBM CREDIT’S REVISED
ORGANIZATION
IBM Credit
General Manager
Caseworker
Caseworker
Caseworker
Caseworker
PERFORMANCE
EVALUATION AND REWARD
STRUCTURES:
ATTRACTING
AND RETAINING
QUALIFIED EMPLOYEES
EMPLOYEE CONTRACTING
OBJECTIVES
• Firms wish to design employee
compensation contracts to maximize
the value of employee’s output net of
costs
• Individuals must receive at least their
reservation utilities – the level of
satisfaction they could receive in their
next best alternative
• Compensation is a key part (but not the
only part) of their utility
BASIC COMPETITIVE MODEL
Assumptions
• competitive labor market
– wages determined by supply and demand
• current market wages costless to
determine
• workers are identical
• all jobs are identical
• no long-term contracts
– all labor hired in “spot” market
– No contracting costs
• all compensation is monetary
THE COMPETITIVE MODEL OF
EMPLOYMENT AND WAGES
– when MRP>wage the
worker adds more to
the value of the
output than to costs
– When MRP< wage
the worker costs
more than what he
adds to the value of
output
Wage (in dollars)
Each firm hires until
MRP=market wage
$
Market wage rate
Marginal revenue product
E*
Number of employees
E
RELAXING THE ASSUMPTIONS
• All jobs are not identical
– employees will choose most desirable
job for given level of pay
– firms must offer compensation for
undesirable characteristics
•
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Workers are not perfect substitutes
Information is costly
Compensation takes many forms
Jobs may be long term
HUMAN CAPITAL
• Individuals differ in their abilities, skills
and training
• General human capital is applicable to
many firms
– workers are willing to pay for general
training => university, community college
• Specific human capital is useful to the
current employer, but does not have
much value outside the job
– firms pay for specific training; challenge of
externalities
COMPENSATING WAGE
DIFFERENTIALS
• Firms pay extra compensation to
attract workers to less desirable jobs
• Individuals averse to these less
desirable job attributes choose a lower
paying job without these attributes
• Workers and firms are matched by
workers’ desire for job attributes and
the firm’s ability to offer them
INTERNAL LABOR MARKETS
• Outside hiring is for entry level jobs
• Promotions are from within
• This helps establish a long-term
employment relationship
ESTABLISHING LONG TERM
EMPLOYEE RELATIONSHIPS
• Result in greater levels of firm-specific
(rather than employee specific) human
capital investment
– Note who captures the value from training
• Greater employee motivation
• Better matching of employees to jobs
over time
PAY IN INTERNAL LABOR
MARKETS
• Since relationships are longer term,
career earnings are used in decision
making instead of MRP
• Firms can pay below MRP initially and
above MRP later in the relationship
• Why not fire older workers?
UPWARD SLOPING
EARNINGS PROFILE
$
Salary (in dollars)
Compensation
Marginal revenue product
T
Tenure with the firm
UPWARD SLOPING
EARNINGS PROFILE
$
Salary (in dollars)
Marginal Revenue Product
Compensation
HOW DOES THIS DIFFER
FROM THE PRIOR CASE?
T
Tenure with the firm
PAY IN INTERNAL MARKETS
• Efficiency wages
– compensation higher than market rates
– can motivate workers not to shirk
– may reduce turnover
• Compensation typically rises with
seniority
– higher productivity
– incentive to work in best interest of firm,
acquire firm-specific human capital
PROMOTIONS AS
TOURNAMENTS
• Employees compete for promotions
within organizational hierarchy
• Promotion systems have drawbacks
– undermines cooperation
– more discrete than monetary rewards
– Peter Principle may apply
– employees may not value promotions
– influence costs may rise
INCENTIVE COMPENSATION
• Owners and employees have different
aims
• Owners wish to maximize profits and
want employees to work diligently
• Employees wish to maximize utility and
take breaks from working
INCENTIVE PROBLEMS
• If the interests of the firm and employee
are perfectly aligned, an incentive
problem does not exist
• Contracts can solve this problem if the
worker’s actions are completely
observable
• There is a trade-off between the
benefits of an action for the firm and
the personal costs born by the
employee
INCENTIVES FROM OWNERSHIP
• One way to avoid these problem is
to sell employees the rights to their
production
• This is seen in franchising and
managerial buyouts
• Limiting factors
• wealth constraints
• risk aversion
• team production
OPTIMAL RISK SHARING
• Most individuals are risk averse
• for given income level, prefer less
dispersion in outcomes
• Shareholders have diverse portfolios
• less concerned about performance of any
one company
• Employees receive substantial income
from single company
EFFECTIVE INCENTIVE
CONTRACTS
• Compensation contracts have two
functions
• motivate employees
• share risk more efficiently
• Employees prefer fixed income to
random income flows
• Fixed incomes do not provide strong
incentives
• Contract must balance these
considerations
FACTORS THAT FAVOR HIGH
INCENTIVE PAY
• The value of output is sensitive to the
employee’s effort
• The employee is not very risk-averse
• The level of risk that is beyond the employee’s
control is low
• The employee’s response to increased
incentives is high (the employee exerts
substantially more effort)
• The employee’s output can be measured at low
cost
INFORMATIVENESS PRINCIPLE
• Use all appropriate information when
evaluating performance
• Consider uncontrollable factors such
as market conditions
• Select benchmarks to support relative
performance measurement
• By measuring employee effort with
more precision, effort choice will be
more efficient
GROUP INCENTIVE PAY
• Individual performance is difficult to
measure
• Group pay encourages teamwork and
cooperation
• Employees have incentives to monitor
each other
FORMS OF INCENTIVE PAY
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Piece rates and commissions
Bonuses for good performance
Prizes for winning contests
Salary revisions based on performance
Promotions
Preferred office assignment
Stock and profit sharing plans
Deferred compensation
Firings for poor performance
DOES INCENTIVE PAY WORK?
• Critics argue that money does not
motivate
• Also they argue it is difficult to design
an effective compensation plan
• Evidence supports that agents do
respond to incentives
PERFORMANCE EVALUATION
• Evaluations provide employees
feedback on achievement and ways to
improve
• Evaluations are used to determine
rewards and sanctions
• Performance evaluation entail
evaluating employees as well as
subunits of the firm
– They can also be very stressful and
divisive
INCENTIVE COMPENSATION
AGAIN
• Principal-agent model
– Employee output: Q = e +   objective
performance measure
– Compensation: W = W0 + Q 
compensating differential is needed
because the employee must absorb the
risk from 
– Note the implications if
 = 0; ( = marginal productivity)
W0 = 0;
=0
IMPLICIT ASSUMPTIONS
• Principal knows agent’s production
function (capabilities)
• Output is single quantitative measure
of performance
• Output can be observed at zero cost
• Employee cannot game the measure
• Employee produces a single output
• Mutually beneficial contract is
feasible
• Employee works independently of
other employees
SETTING PERFORMANCE
BENCHMARKS
• Time and motion studies
– Engineers estimate the amount of time a
task requires
– Determines most effective work method
• Past performance and ratchet effect
– Employees have incentives to only meet
the goal and not exceed it
MEASUREMENT COSTS FOR
PERFORMANCE EVALUATION
• Accounting systems may need to be
developed
• Information systems improved
• Value-maximizing firm improves
measures as long as incremental
benefits justify costs
OPPORTUNISM
• Gaming the system
– Employees may engage in dysfunctional
activities to improve their evaluations
• Horizon problem
– Short-run objective performance measure
may cause employees to focus on results
that influence their evaluation only over
their remaining time with the firm
RELATIVE PERFORMANCE
EVALUATION
• Evaluate worker output relative to their
co-workers in the same job
• Within the firm
– jobs not always identical
– group has incentive to punish “rate
busters” (People who “set the curve”)
– incentive to hire less competent workers
• Across firms
– data hard to obtain
SUBJECTIVE PERFORMANCE
EVALUATION
• Firms often use subjective evaluation
along with objective measures
• Multiple tasks and unbalanced effort
– Workers have incentives to concentrate
on activities that are easily measured
– The subjective measure will allow the
supervisor to determine cooperation and
other difficult to measure activities
SUBJECTIVE EVALUATION
METHODS
• Standard rating scales
– Rank employees on various performance factors
• Goal-based systems
– Set annual goals and then measure whether the
employee achieved them
• Frequency
– Often more frequent reviews are too costly
– May be beneficial with new hires
• 360 Degree Performance Reviews