Michael Gibbs is Clinical Professor of Economics at the University of Chicago Graduate School of Business. Gibbs earned his PhD in Economics from the University of Chicago. He is a leading empirical researcher in the field of personnel economics, and has received awards for excellence in research and teaching.

ABOUT THE AUTHORS iii

PREFACE v

ACKNOWLEDGMENTS ix

PART ONE SORTING AND INVESTING IN EMPLOYEES 1

CHAPTER 1 SETTING HIRING STANDARDS 3

An Example: Hiring RiskyWorkers 3

New Hires as Options 3

Analysis 5

A Counterargument 7

Setting Hiring Standards 9

Balancing Benefits Against Costs 9

Foreign Competition 11

The Method of Production 12

How Many Workers to Hire? 15

Other Factors 16

Making Decisions with Imperfect Information 17

Make a Decision Independent of Analysis 17

Estimate the Relevant Information 17

Summary 19

Study Questions 20

References 21

Further Reading 21

Appendix (available online)

CHAPTER 2 RECRUITMENT 22

Screening Job Applicants 24

Credentials 25

Learning a Worker’s Productivity 26

For Whom Is Screening Profitable? 28

Probation 30

Signaling 32

Who Pays and Who Benefits? 35

Examples 35

Signaling More Formally: Separating and Pooling Equilibria 36

Which Type of Firm Is More Likely to Use Signaling? 38

Summary 38

Study Questions 40

References 40

Further Reading 41

Appendix (available online)

CHAPTER 3 INVESTMENT IN SKILLS 42

Matching 44

Investments in Education 45

Effects of Costs and Benefits 47

Was Benjamin Franklin Correct? 49

Investments in On-the-Job Training 51

General versus Firm-Specific Human Capital 54

Who Should Pay for Training? 56

Implications of On-the-Job Training 61

Rent Sharing and Compensation 63

Summary 66

Study Questions 67

References 68

Further Reading 68

Appendix (available online)

CHAPTER 4 MANAGING TURNOVER 69

Is Turnover Good or Bad? 69

Importance of Sorting 70

Technical Change 70

Organizational Change 71

Hierarchical Structure 71

Specific Human Capital 71

Retention Strategies 72

Reducing Costs of Losing Key Employees 73

Embracing Turnover 75

Bidding for Employees 76

Raiding Other Firms: Benefits and Pitfalls 76

Offer Matching 80

Layoffs and Buyouts 82

Who to Target for Layoffs 83

Buyouts 86

Summary 90

Study Questions 91

References 91

Further Reading 92

Appendix (available online)

PART TWO ORGANIZATIONAL AND JOB DESIGN 93

CHAPTER 5 DECISION MAKING 95

The Organization of an Economy 95

Markets as Information Systems 96

Markets as Incentive Systems 98

Markets and Innovation 98

Benefits of Central Planning 98

The Market as Metaphor for Organizational Design 100

Benefits of Centralization 102

Economies of Scale or Public Goods 102

Better Use of Central Knowledge 103

Coordination 103

Control 104

Benefits of Decentralization 105

Specific versus General Knowledge 105

Other Benefits of Decentralization 107

Decision Management and Control 108

Decision Making as a Multistage Process 108

Creativity versus Control 110

Investing in Better-Quality Decision Making 118

Summary 121

Study Questions 123

References 123

Further Reading 124

Appendix (available online)

CHAPTER 6 ORGANIZATIONAL STRUCTURE 125

Types of Organizational Structures 126

Hierarchy 126

Functional Structure 128

Divisional Structure 129

Matrix or Project Structure 133

Network Structure 136

Which Structure Should a Firm Use? 139

Coordination 140

Two Types of Coordination Problems 140

Coordination Mechanisms 142

Implementation 145

Span of Control and Number of Levels in a Hierarchy 145

Skills, Pay, and Structure 148

Evolution of a Firm’s Structure 149

Summary 150

Study Questions 152

References 153

Further Reading 154

CHAPTER 7 JOB DESIGN 155

Patterns of Job Design 155

Optimal Job Design: Skills, Tasks, and Decisions 159

Multiskilling and Multitasking 159

Decisions 163

Complementarity and Job Design 164

When to Use Different Job Designs 165

Taylorism 166

Factors Pushing Toward Taylorism or Continuous Improvement 168

Intrinsic Motivation 171

Summary 173

Study Questions 175

References 176

Further Reading 177

Appendix (available online)

CHAPTER 8 ADVANCED JOB DESIGN 178

Teams 179

Group Decision Making 179

Free Rider Effects 179

When to Use Teams 180

Other Benefits of Team Production 181

Implementation of Teams 186

Team Composition 187

Effects of Information Technology 190

Effects on Organizational Structure 190

Effects on Job Design 193

High-Reliability Organizations 196

Summary 198

Study Questions 199

References 200

Further Reading 200

Appendix (available online)

PART THREE PAYING FOR PERFORMANCE 201

CHAPTER 9 PERFORMANCE EVALUATION 207

Purposes of Performance Evaluation 208

Ways to Evaluate Performance 208

Quantitative Performance Measurement 208

Risk Profile 209

Distortion 210

Manipulation 214

Match of the Performance Measure to Job Design 215

Subjective Evaluation 218

Why Use Subjective Evaluations? 219

Reduce Distortion and Manipulation 220

Practical Considerations 222

Summary 227

Study Questions 228

References 229

Further Reading 229

CHAPTER 10 REWARDING PERFORMANCE 230

How Strong Should Incentives Be? 233

Intuition 233

Imperfect Evaluations and Optimal Incentives 237

Summary: How Strong Should Incentives Be? 242

Paying for Performance: Common Examples 243

Rewards or Penalties? 243

Lump Sums, Demotions, or Promotions 246

Caps on Rewards 249

Applications 251

Profit Sharing and ESOPs 251

Organizational Form and Contracting 253

Motivating Creativity 254

Summary 255

Study Questions 256

References 257

Further Reading 257

Appendix (available online)

CHAPTER 11 CAREER-BASED INCENTIVES 258

Promotions and Incentives 261

Should Promotions Be Used as an Incentive System? 261

Promotion Rule: Tournament or Standard? 262

How Do Promotions Generate Incentives? 267

Advanced Issues 271

Evidence 275

Career Concerns 276

Seniority Pay and Incentives 276

Practical Considerations 278

Summary 279

Study Questions 281

References 282

Further Reading 282

Appendix (available online)

CHAPTER 12 OPTIONS AND EXECUTIVE PAY 284

Employee Stock Options 285

Stock Options–A Brief Overview 285

Should Firms Grant Employees Options? 286

Options as Incentive Pay 288

Executive Pay 293

What Is the Most Important Question? 293

Executive Pay for Performance 295

Other Incentives and Controls 297

Do Executive Incentives Matter? 299

Summary 302

Employee Stock Options 302

Executive Pay 303

Study Questions 303

References 304

Further Reading 304

Appendix (available online)

PART FOUR APPLICATIONS 307

CHAPTER 13 BENEFITS 309

Wages versus Benefits 309

Why Offer Benefits? 312

Cost Advantage 312

Value Advantage 313

Government Mandate 315

Implementation of Benefits 316

Improving Employee Sorting 316

Cafeteria Plans 317

Pensions 319

Paid Time Off 327

Summary 329

Study Questions 331

References 331

Further Reading 332

CHAPTER 14 ENTREPRENEURSHIP AND INTRAPRENEURSHIP 333

Entrepreneurship 334

The Choice to Become an Entrepreneur 335

Intrapreneurship 344

Internal Markets 345

Creativity versus Control 347

Recruiting 347

Motivating Creativity 348

Speed of Decision Making 350

Reducing Bureaucracy 350

Continuous Improvement 351

Summary 353

Study Questions 353

References 354

Further Reading 355

Appendix (available online)

CHAPTER 15 THE EMPLOYMENT RELATIONSHIP 356

Employment as an Economic Transaction 356

Perfect Competition 356

Imperfect Competition 357

Complex Contracting 358

Summary 361

Communication between Management andWorkers 362

Communication from Management to Workers 362

Communication from Workers to Management 364

The Optimal Level of Worker Consultation 366

Improving Cooperation 370

From the Prisoner’s Dilemma to Employment 372

Reputation and the Employment Relationship 374

Investing in Reputation 375

Summary 381

Personnel Economics in Practice 381

Study Questions 383

References 383

Further Reading 384

Appendix (available online)

GLOSSARY 385

INDEX 393

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