In this lesson, we're using economic principles to generate lessons for managers and human resource professionals when work is the daily grind. That is when workers see their job as negative activity that they endure simply to earn income. Now when this is true, that a particular concern that emerges is with opportunism. Now as we saw in the last video, when workers are interested in their own goals, when it's difficult or costly to observe the elements of their. Work effort, then we should be concerned with Principal-Agent Problems. Principal-Agent Problems can take numerous forms. For example, consider my own situation. My university can certainly observe my teaching and my research at a high level, but it's difficult for them to observe my extra effort on a daily basis. So am I devoting extra effort to my research or towards my teaching? Maybe the university wants me to devote extra effort toward my teaching. But if the labor market, other universities, reward research instead of teaching, than if I'm only interested in my own salary and it's hard for the university to observe where I'm devoting extra effort. Then there's a principle agent problem at work, and I might be devoting more extra effort to my research rather than my teaching. Think of a different example. A manager might want to keep high performing employees in her work group, rather than sharing them with other divisions in her company. Or in the age of sale, a couple of centuries ago, Navy captains might have preferred to try to capture wealthy enemy merchant ships rather than engaging the enemy Navy in battle which would be more risky and more costly. Now, if we add lousy work. Whether as a pain cost or as an opportunity cost, then we have particular concerns with shirking. Now in economic theory the number one solution to shirking problems specifically are principal age and issues more generally is incentives. We want to make it in the self interest of rational workers to act in the interest of the organization. How do we do that? Well we remember what motivates economic workers. What motivates economic workers? Money. So that's where we get back to financial incentives, providing money to employees. Make it in their self-interest to exert more effort. Now under simple conditions economic theory indicates that the optimal incentive, is to sell workers their job for a fixed fee, and then let them keep all of the revenue they generate in return. Sounds crazy, right? Well, there's actually some example of this arrangement, and so it's not completely crazy to think about workers buying their jobs. Some taxi drivers rent their cabs for a day, and then keep what they generate. Some hair stylists rent their chair, and the keep the money that they bring in. However, for many jobs this isn't feasible. But that's okay because the point here isn't to take this economic result literally. Rather, you should be looking for broader lessons. And the broader lesson here is that the more you can make your workers feel like their own entrepreneurs within their jobs, the stronger their performance will be. That is, if they're motivated by financial rewards. And so therefore, there's a lot of different types of pay-for-performance plans. There's merit pay, piece rates, incentive payments, performance bonuses, gain sharing payments, etc. And this will be covered in the final course on compensation in this specialization. But workers might be bothered by uncertainty. What economists call risk aversion. Workers and their families have bills to pay and they probably want some kind of predictability in their pay. And so it can be hard to recruit and retain workers if compensation is excessively risky. So you need to find the right balance between a fixed salary, which serves as a form of insurance against income loss or income risk, and variable incentive pay. Too much insurance and workers don't have an incentive to work hard. Too little insurance and workers will work elsewhere. Another incentive mechanism that is prominent in economic scholarship Is the use of contest or tournaments. This can take the form of employee of the month contest, bonus contest or tournaments to determine who will win the job promotion. The common denominator here is that employees know about a prize. That the prize is large enough to compensate for the risk of losing, workers will exert effort to win. So in conclusion, there's many different types of incentives, and economists see these as potentially very powerful solutions to principle agent problems, shirking, and opportunism. However, they in fact might be too powerful, and you need to guard against unintended consequences. One set of unintended consequences comes under the phrase of what gets measured gets done. If you provide and incentive for a certain part of a job but not other parts of that job, then self-interested workers might over-emphasize the incentivized part. This is an easy mistake to make when some parts of a job are easier to measure than others. A second unintended consequence we could call overstimulation. Workers might get greedy and figure out ways to undermine the incentive plan. Economists who study this are familiar with the data entry example, where a company provided an incentive for workers just to enter keystrokes. And so, self-interested workers quickly figured out that they could just blindly type things into their computer and they'd get paid for it even though they're not paying attention to the accuracy of their data entry. This is an example of what I call over stimulation. Another unattended consequence is incentives can undermine teamwork. Concerns with free riding reduces the power of incentives, for example. Tournaments turn coworkers into competitors, which probably isn't how you want them to work with each other. Tournaments also provide incentives for workers to find non-productive ways to win the tournament. So for example they might suck up to the boss. This probably isn't how you want your workers to be devoting their energies and their effort. Also incentives might reduce intrinsic motivation, might crowd out intrinsic motivation. If your workers are already self-motivated, you don't want to ruin this by making their jobs all about money. So in some, incentives can be very powerful. But so powerful, that you need to be cautious and use caution when using incentives.
