[MUSIC] Personnel economics is
the application of economic principle statistics, economic theory,
mathematics, even. To questions that were traditional
human resource questions. So questions that people
would not normally think of as lending themselves easily to economics,
motivating workers. Hierarchical kinds of questions, how much
authority should you give to your workers. Those issues that were traditional in
human resources were dealt with in quite a different way. So if you think about organizational
behavior, which is another field in our business school and in most business
schools, they think of it more from the psychology point of view, or
sometimes the sociology point of view. Were as ideal with it, and to be honest,
I would say a harder nosed way. More mathematical,
more statistical way, and that’s what personnel economics is about. [MUSIC] If you look cross countries and
you say, in which countries have workers enjoyed the highest wage gain,
say, over the past 15 years? And then you say,
in which countries have workers been most productive in the past 15 years? What you’ll find is that the correlation
between those two is very, very strong. What that means is that if
you go across countries and you look at these countries that are being
effective in raising worker productivity, are also the ones where workers
are seeing their wages grow. So that’s really important. [MUSIC] One of the most traditional
ways to motivate workers and to increase both their productivity and
their earnings, is to pay them something
that’s called a piece rate. Most of us are familiar with piece rates. There are a couple of obvious examples. Uber is a piece rate. Why is Uber a peace rate? Well, because you basically get paid for
the number of rides that you give, depends on the amount of
time that you spend driving. But more than that, it depends on
the actual amount of miles that you drive. And so they’re paying you on
the basis of your output. That’s a very effective
way to motivate people. And of course, if you look at Uber
drivers, they’re pretty darn motivated. They work pretty hard,
they work long hours. They are very good at
figuring out the system, how best to get rides,
where to locate at certain points in time. What does that for them? The fact that they are directly
paid on the basis of their output. So that’s a great motivator. [MUSIC] How do you motivate people in situations
where output is difficult to measure? Most of those kinds of
jobs are managerial jobs. And managerial jobs are important for the economy because they are the basis
of much of our productivity. It’s not just the workers, it’s
the people who are managing the workers, supervising them,
teaching them, guiding them. How do you motivate the teachers and
the motivators? Essentially what you have to do, is you have to pay on the basis
of relative performance. So something that I came up
with a long time ago, again, in my youth it’s called tournament theory. [MUSIC] What tournament theory is about is it’s
kind of obvious when think about it. It’s not very complicated, you kind of
wonder why no one thought about it before. But it’s basically the idea that
firm structure, their compensation, in the same way that people run
tournaments, sports tournaments. So for example, if you think
about Wimbledon tennis match, and you say, how does Wimbledon work? Well, Wimbledon works by
paying a price to the winner. And second place price to
the loser of the finals, because that’s the second place
person in the tournament. The difference between
the winner’s prize and the loser’s prize serves
to motivate those players. Now they would be motivated even
if they didn’t have that prize. But depending on the size of that prize,
they’ll be motivated even more. So for example, if there were a million
pounds at stake in winning that tournament, people would be
highly motivated to play. And that’s what happens in business. So what tournament theory talks about
is first of all how to setup those implicit contests,
the competition between these workers. Do it in a way that doesn’t undermine
the firm because sometimes competition can be bad. They’ll work to sabotage
one another essentially, because they’re trying to
get the next promotion. And then finally, to think about how big
a raise should you give those individuals when they get promoted
from one level to another. To both motivate them below and
then give them incentives above. [MUSIC] Another way that workers are sometimes
compensated is on the basis of the team. Why would you do that? Well, sometimes people need to cooperate. And in order to get them to cooperate,
you have to pay them on the basis of their joint output, not on
the basis of their individual output. Let me give you an example. There’s a good example by one of my
colleagues here, Kathryn Shaw who with a couple of co-authors did a very
nice study of a firm in Brazil, that was actually a law firm. And what they did was they had
initially paid their lawyers on the basis of their billings. Straight on the number of billings. That’s a measure of output, sounds great. Because you can easily observe it. You basically know who’s doing what, you
can motivate them very effectively, but here’s the problem. Because they were being paid on
the basis of their own billings, the senior lawyers who had the ability
to allocate cases to one another, took all the great cases for themselves, even when they weren’t necessarily
the best partner to handle the job. And so what the firm did, is they said,
our junior people, some of whom are highly qualified to be working on
these cases, are not getting the work, because the senior guys
are taking it all for themselves. What do we do? We’ve gotta change the compensation
structure so that you’re paid not only on your own billings, but you’re essentially
paid on the profitability of the firm. Now, because you’re paid on
the profitability of the whole firm or of a sector of the firm. You care not only about how well you do,
but you also care about how
well your co-workers do. As a result, there was an enormous transformation
in the way that worked was allocated. And an enormous transformation as
well in the productivity of the firm. So profits went up, billings actually went
up, and the work was better handled and people were much happier
as a result to that. [MUSIC] Team compensation can be very effective. One problem with team compensation
is it doesn’t always work, why not? There’s something in economics
called the free-rider problem. I’m sure many of your listeners
have heard about that. But the free-rider problem comes about
when you have an incentive to shirk, and basically put
the burden on someone else. Some of your viewers may remember
when they were in school. Perhaps even at Stanford Business School,
although we don’t have many shirkers here. But if you are involved in a team project, suppose five of you have
a homework assignment. You have to get together and write up
the assignment for the whole team. Sometimes one person will work
harder than another person. And sometimes even a teammate might be
critical of the other teammate because of the behavior of the other teammate. Not putting in the appropriate amount of
effort, the appropriate amount of time. So the free-rider effect
comes about in teams and as the team size gets larger, the
free-rider effect becomes more pronounced. Because your ability to affect the total
output of the team gets smaller and smaller. So team output, team compensation
can be affected in a strong way as long as the teams
are structured appropriately. First of all, you have to make sure that
the teams involve people who are highly complementary to one another. So you want to make sure that
I’m working with someone who’s output will benefit greatly
from my input and vice versa. You also want to make sure that
the team is small enough so that we can observe each other. We can monitor each other,
we can motivate each other. And that’s an important component as well. So firms can use team compensation but they have to be pretty careful
about the way they set it up. [MUSIC] People often work for
a long time in a company. And the question is, what do you do
to motivate managers when they’re essentially done with the tournament? What do I mean by done
with the tournament? Look at me, I’ve been the equivalent of a
middle level manager for most of my life. I’m a senior professor at Stanford,
but there’s nowhere for me to go. I have no aspiration to be a dean or
anything like that. So how do you keep me motivated? Well, again, there are ways that
you can do this that have to do with compensation,
in addition to nonmonetary forms. But let me give you the one
that’s compensation. So when I was a young guy and I was
working really hard trying to get tenure, at this point it was at
the University of Chicago. And I was looking at my senior colleagues,
and while they’re very smart and very productive people, I still thought
that I was working a lot harder. And even more productive. I wrote a lot of papers in those days,
and I still try to write a lot of papers. But when I was a young person I was
probably better at it than I am now. And yet, I was paid a lot less
than my senior colleagues. And I thought, why is that? Isn’t this kind of crazy? I’m the guy doing all the work and
the others guys making all the money. And so I thought about it, and
I realized, well actually, that motivates me because what happens
is as a result of seeing my senior colleagues make a lot of money,
I want to be a senior colleague. And that was true throughout
most of my career. So when I was in my 30s and 40s, at that point I was already a tenured
professor with an endowed chair. There was pretty much nowhere for
me to go in the tournament. But I still cared a lot about being
successful in the organization. Not only because I wanted
Stanford to succeed and I wanted myself to succeed, but also because I wanted to be well-treated
in my old age, which I have now reached. And I am well-treated, and I think part of that is because I
try to continue to be productive. But part of that is also payoff for
what I did as a younger man. And that motivates the younger generation. It motivates the 40 and 50-year-olds,
many of whom are still very productive, and we want to keep those
people very productive by their ability to see
how Stanford treats me. They say, all right, if I perform well,
I understand that someday I’ll be like lazier and maybe I’ll be
a little bit overpaid but it’s okay, it’s compensation for
what I’m doing right now. [MUSIC]

Work Is a Competitive Sport
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