[3] The subject has been described as significant and different from sociological and psychological approaches to the study of organizational behavior and human resource management in various ways.
It analyzes labor use, which accounts for the largest part of production costs for most firms, by formulation of relatively simple but generalizable and testable relationships.
It also situates analysis in the context of market equilibrium, rational maximizing behavior, and economic efficiency, which may be used for prescriptive purposes as to improving performance of the firm.
[4] For example, an alternate compensation package that provided a risk-free benefit might elicit more work effort, consistent with psychologically-oriented prospect theory.
[7] Subjects treated (with footnoted examples below) include: The field can be traced back to 1776 when Adam Smith, a British economist, suggested that within the labor market equilibrium, a trade-off between a worker's wages and non-monetary working conditions could exist.
[16] Personnel economics began to emerge as a distinct field from a flurry of research in the 1970s that sought to answer the questions of how prices of goods and services traded within a firm are determined.
[17] The relationship is represented at a general level in the principal-agent problem whose solution is the firm modeled as a set of contracts for efficiently allocating risk and monitoring the performance of the production team and its members.
The subject was developed in addressing those questions, including examination of pay structure and promotions within hierarchical organizations.
[19][20] Major theories of the subject developed in the late 1970s and 1980s from the research of Bengt Holmström,[20] Edward Lazear,[21] and Sherwin Rosen[22] to name but a few.
[26] Other empirical studies conducted then utilized data from sports (e.g. golf tournaments and horse racing).
[28] From the 1990s, there was a further surge of empirical tests of the theory from wider availability of personnel records of large companies to researchers and interest in the relation between compensation and productivity[29] and the implications of imperfect labor markets and rent-seeking behavior for the subject.
[34] Advantages of Tournament Theory: Disadvantages of Team Production: The Principal-Agent Problem is based on the relationship between an employer (principal) and an employee (agent).
Inequitable Pay: Fixed payment with monitoring can be prone to delays and interruptions, making it unreasonable to punish agents for issues outside of their control.
Additionally, there is a potential risk of having a free-rider problem, where individuals within a team can get away with no contribution to the work and still be compensated the same amount as their peers.
[38] Team production is suitable for many projects that require a variety of skill sets, and it enables firms to produce high-quality work while remaining cost-effective.
Additionally, teamwork offers a chance for individuals to learn from each other and develop new skills, leading to better job satisfaction and morale.
If left unresolved, organisations run the risk of turnover as long-term employees may feel undervalued and start looking for work elsewhere.
This would make equity more relevant in close comparisons,[34] boost morale and worker efficiency, and provide insurance to employees during uncertain outcomes, such as bad market conditions.
However, pay compression leaves employees vulnerable to moral hazard problems, and they may put less effort into their work.
Pay compression can help in this case by closing the salary gap between job levels, which in turn gives less incentive for employees to sabotage their co-workers.
[39] Pay compression is not a one-size-fits-all solution, and organisations must carefully consider the potential benefits and drawbacks before implementing it.
By analysing their specific situation and goals, organisations can determine whether pay compression is a viable solution for their compensation issues.
Human Resource Practices in Personnel Economics refer to the methods and techniques that firms use to manage their workforce.