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Personnel Economics

Personnel economics broadly refers to the practice of using economic, statistical and mathematic methodology to affect human resource practices and employee morale for the goal of maximising business productivity. The focus of personnel economics is determining how to best hire, retain and motivate employees. However, the main issue hindering this goal is called incentive conflict. Namely that firms want agents that work in the business’s best interest but the agents themselves often have different goals. This incentive conflict leads to adverse selection, in that in the hiring process one side, the agents, have information relating to their motivation and goals that the firm doesn’t. Furthermore, it also leads to a moral hazard issue in that employees may be more likely to shirk once they are confident that the business will incur the cost. There are two main schools of thought of how to best reduce or eliminate these issues. The first method involves a fixed payment and constant monitoring of employees to reduce shirking. The second involves using incentive pay and little or no monitoring to ensure trust is built between employee and manager in hopes of motivating greater effort through reciprocity. Currently there is no clear best method with both schools having several problems. One theory suggests that using corporate social responsibility, without public intervention the firm actively promotes social and moralistic goals, i.e. refusing to use child labour, could act as a screen against moral hazard and attract more productive workers (Brekke, Nyborg 2004). This is in contrast to contemporary economics that suggests cutting production costs leads to further profitability. However, the empirical findings indicate that many employees prefer social responsibility and may actually pay a large premium, likely in the form of a reduced wage relative to other similar firms, to help the firm (Frank 2003). Furthermore, it was found that firms with considered less socially responsible had to pay significantly higher wages. On average, for profit firms payed 59% in wages more compared to non-profit ones (Frank 2003). This theory contends that firms could exploit the correlation between social values to attract productive workers, thus reducing the issue of shirking, and also allow relatively lower wages (Brekke, Nyborg 2004). The gift exchange theory follows the second method. Simply put the workers give the firm a gift in terms of labour or effort in excess of their minimum work standard. While the firm’s gift is extra wages or other non-monetary benefits such as vacation time or flexible hours. The gift exchange theory posits that a ‘gift’ from the firm, i.e. increased wages, will have a corresponding increase in workplace productivity as employees will want to reciprocate with their own ‘gift’ of greater effort. However, several experiments dispute the long-term effectiveness of the gift exchange theory as they found that positive reciprocity depreciates over time. Kalk and Kosfeld (2006) found that excess monitoring causes distrust between employee and manager leading to the issue they call the hidden costs of control. Namely that the less trust an employee feels they have with their manager the less motivated they are to perform well. This is demonstrated further as empirical evidence shows that principals who trust their agents on average induce a higher performance. This theory coincides with the gift exchange theory as in a sense employee are afforded a ‘gift’ in reduced monitoring which improve morale, as workers feel appreciated, thereby instilling a desire to reciprocate by giving greater effort.

References Armin Falk, M. K. (2006). The Hidden Costs of Control. American Economic Review, 1611-1630. Frank, R. (2003). What Price the Moral High Ground? . Ithaca, New York: Connel University. Kjell Arne Brekke, K. N. (2004). Moral hazard and moral motivation:. Oslo: Department of Economics, Univsersity of Oslo.