Lecture Labour market economics: Chapter 13 - Dwayne Benjamin, Morley Gunderson, Craig Riddell

Chapter 13 - Optimal compensation systems. This chapter presents the following content: Internal and external labour markets, seniority and productivity over the lifecycle, superstar wages, mandatory retirement, CEO salaries, tenure, matching offers of raiding firms.

© 2002 McGraw-Hill Ryerson Ltd Chapter 13-1

Chapter Thirteen

Optimal Compensation

Systems

  Created by: Erica Morrill, M.Ed

      Fanshawe College

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­2

Chapter Focus

 Internal and external labour markets

 Seniority and productivity over the lifecycle

 Superstar wages

 Mandatory retirement

 CEO salaries

 Tenure

 Matching offers of raiding firms

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­3

Compensation System

 Features may be peculiar and inefficient

 Internal labour markets contrary to

neoclassical model

 Explaining these features is new area of

of research

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­4

Agency Theory and Efficiency

Wage Theory

 Principal-agent

theory

 Efficient contact

 Problems

 monitoring costs

 asymmetric

information

 Leads to

“truth-telling” contracts

 Efficiency Wages

 Wages affect productivity

 Paid according to MPL in the firm

 Causality can run both ways

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­5

Economics of Superstars

 VMP reflects

 the size of the market

 contribution to the productivity of others

 Small skill differences get magnified

 when large audience can share the cost

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­6

Salaries of CEOs

 VMP is high if individual improves the

productivity of a number of people

 CEOs of large multinationals

 responsible for large numbers of

customers, employees and suppliers

 High salaries ensure specific talents are matched with the organization

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­7

Salaries as Tournament Prizes

 Efficient when executives are ranked

according to the relative value of their

contribution to the organization

 Individuals are ranked on the basis of their performance not necessarily their individual productivity

 Create disincentives

 discourage cooperation

 disrupt the performance of competitors

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­8

Efficient Pay Equality and

Employee Cooperation

 Trade-offs in determining the optimal degree of inequality

 This differs with situation

 affect on the output of others

 different levels or structures

 person’s nature

© 2002 McGraw­Hill Ryerson Ltd Chapter 13­9

Up-or-Out Rules

 May be efficient given imperfect and

asymmetric information

 forces employers to promote skilled

workers

 allows new workers in junior spots

 enables employers to remove disgruntled employees

 compels managers to make hard decisions

Chapter 13­ 10

Raiding, Offer-Matching

 Winner’s Curse

 raiding other organizations for top talent

 encourages offer-matching if employee is worth the amount

 Mitigating circumstances

Chapter 13­ 11

Piece Rates

 Positive work incentive effects

 Rewarded directly for producing more output

 Measuring and monitoring issues

Chapter 13­ 12

Executive Compensation

 Motivated by the need to pay “prizes” to top person

 Induce incentives to “win the

tournament prize”

 Executive with the right talent matched with the organization that needs and

values that talent

Chapter 13­ 13

Deferred Wages

 Wages are above productivity for senior employees

 Even larger if consider pensions

 Exist in firms with long-term

commitment to continue contract

Chapter 13­ 14

Rationales for Deferred

Compensation

 Ensure honesty and work effort

 Reduce need for daily monitoring

 Reduce turnover

 Provide workers with financial interest in the firm

Chapter 13­ 15

Rationale for Mandatory

Retirement

 To enable deferred wages

 provides the termination date for contractual

arrangements with deferred wages

 Facilitate worksharing

 opening up promotion and employment

opportunities

 Certainty for planning new staff, pension

obligations and medical and health

expenditures

Chapter 13­ 16

Figure 13.2 Mandatory Retirement

Age

Wage,

productivit

VMP, productivity

MR Age

Chapter 13­ 17

Arguments Against Mandatory

Retirement

 Age discrimination

 Employment standards and human

rights legislation does not cover workers over 65

 Improve the viability of public and

private pensions

Chapter 13­ 18

End of Chapter Thirteen