Personell Economics 1 Nonmonetary Compensation Money isn‘t everything!? But it is the best metric! (Value of goods difficult to compare – depends on preferences!) –Money is fungible (one euro as good as the next) –Money is easily traded for goods Rewards of a job consist of different elements, only some of them are money, but all have value expressible in money.

Personell Economics 2 How to measure nonmonetary compensation? Monetary equivalent: How much would a worker „pay“ for certain form of nonmonetary compensation, e.g. flex-time. Firm can use information to decide whether to offer this nonmonetary job attribute or not.

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4 Converting nonmonetary attributes to monetary equivalents Preferences for money and nonmonetary attributes can be represented by indifference curves. Firms can afford different packages of money and nonmonetary benefits. –Example: Car manufacturer versus Software developer.

Personell Economics 5 Converting nonmonetary attributes to monetary equivalents Example: Set Wc=15, Ws=10, Tc=0.2, Ts=0.4 –Monetary equivalent for 10 % flex-time = 2.5 €: Worker is willing to give up 2.5 € to increase flex-time by 10 %. Calculated by compensation consultants (use data on wages and job characteristics)! Firm can decide which compensation package would be optimal from own perspective (e.g. grant flex time or not?)

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8 Estimation of monetary equivalents Compensation consultants need large number of firms with information on wage and nonpecuniary job attributes. Can estimate regression: wage = a + b (proportion flex-time) + c (proportion flex-time) 2 Example: a = 30, b = -50, c = 25 a is wage without any flex time € 30 wage = 30 – 50 (prop. flex-time) + 25 (prop. flex-time) 2 flex-time = 1 %: wage = 30 – 50(0.01) + 25 (0.0001) = € If all workers are identical, the curve traced out by market equilibria is an indifference curve.

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10 Extending the analysis to more than one non-monetary factor E.g. include also probability of injury! wage = a + b (proportion flex-time) + c (proportion flex-time) 2 d (prob. of injury) + e (prob. of injury) 2 Example: a = 30, b = -50, c = 25, d = 1000, e = 100,000 if flex-time = 0, and injury prob = 0  wage = 30 if flex-time = 0, and injury prob =  wage = 30 – 50(0) + 25(0) + 10,000 (0.001) ( ) = Compensating wage differential

Personell Economics 11 Heterogeneous preferences Identical preferences not realistic! Assume two types of individuals –Windsurfers –Chess players Windsurfers are more willing to give up money for flexibility. Car manufacturer cannot give as much flexibility as software firm.  Sorting!

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Personell Economics 13 Heterogeneous preferences Slope of indifference curve = monetary equivalent of flex- time Wage that chess player is prepared to give up for additional flexibility is smaller than relative market price (given by regression estimate --- line C-S) Windsurfer is prepared to give up more money than the market price to get additional flexibility. –Regression coefficient obtained from data understates monetary equivalent of flexibility to those already chosen to work at flexible firms, –overstates monetary equivalent for those who already chose less flexible jobs.

Personell Economics 14 Sorting of Workers and Firms Firms might have different costs in offering more flexible schedules: –Car producer: everybody has to be there at the same time –Software company: anything goes Car producer would require big wage concession for allowing more flex time Windsurfers will go to software company, chess- players to car producer Optimal sorting can be achieved

Personell Economics 15 Conclusions heterogeneous preferences Regression coefficient can be interpreted as bound for true monetary equivalent –Lower (upper) bound for those who choose firms with heavy (light) concentration of that factor Regression estimate reflects true market value of the factor (on the market you have to pay € x to get a job with more flex time) Preference continuum smoothens regression line –Not only two extremes of individuals exist, but rather a continuum

Personell Economics 16 Undesirable Job Characteristics Can be considered a „bad“!  Form of indifference curves? E.g. indifference curves for wage and injury probability?

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Personell Economics 18 Measurement problems Some nonpecuniary factors important to workers may be difficult to measure, e.g. respect, human relations in firm, status! Do workers look only at absolute level of these factors or do they look at relative levels? –More money than the colleagues? –Status is by definition relative (Executive Vice President…) Awarding (non)monetary rewards with relative preferences has negative external effects on other workers

Personell Economics 19 Perspective of marginal worker Two jobs: 1.Construction workers (assume earn 20 €) 2.Chimney sweeper Some people prefer construction work, some chimney sweeping. Wage of chimney sweepers depends on preference of marginal worker in that sector. The larger the demand for certain professions, the lower the monetary equivalent of status. More workers employed  marginal worker less likely to view as high status field!

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Personell Economics 21 Can indexes help in setting pay scales Features of particular job, e.g. –skill level, –technical know-how, –accountability, –pleasantness of work are rated and translated into points Points are translated into wages

Personell Economics 22 Indexes Equal Pay Act: illegal to pay men and women different wages for doing the same work. But men and women often work in different jobs! Test for discrimination by using indexes. Monetary equivalents can be calculated for job characteristics. If women earn less than predicted by monetary equivalents, this may be due to discrimination.

Personell Economics 23 Indexes difficult to use Subjective Rating First step: determination of level of job characteristics, „objectivity“ of responsible people? Committee selection important for evaluation outcome! Index Subjectivity Ratings crucially depend on scales used for different dimensions. Better use regression techniques to determine market wages and compensating differentials

Personell Economics 24 Wages and Benefits (ch. 15) Big part of wage costs is spent on benefits Private health insurance, firm restaurant, firm holiday (Betriebsausflug), kindergarten… Why not pay out the costs in form of wages? –Individuals do not like to be forced into consumption, utility of forced consumption will be lower –Benefits only advantageous if Benefits for the whole workforce are easier to buy/construct Tax treatment favorable Consuming particular benefit may be beneficial to firm (going to fitness club)

Personell Economics 25 Not all workers value the benefit Ex. Private health insurance or life insurance –Young workers do not like them –They would prefer higher wages –Similar for firm child care Offer a Cafeteria plan: –Workers get € 300 as benefits plus a menu with different benefits and associated prices Child care € 100 Pension plan € 150 … –Workers can chose

Personell Economics 26 Benefits and Sorting Choice of benefits can induce sorting of workers with particular charcteristics to the firm –Family-oriented workers –W. High/low risk aversion –Workers with high desire for retraining Without having to distort the pay scale which might cause problems –More difficult with cafeteria plans, if some parts of the plan are not subsidized. –Might also lead to adverse selection of workers Private health insurance will attract less healthy workers