The approach applies notions from economics, such as incentives, opportunity
costs, and diminishing returns, to HRM issues such as recruitment and selection,
payment systems, training, lay-oVs, job ladders, teamworking, and outsourcing.
DiVusion of new ideas about agency and contracts among economists were
perhaps a catalyst for the founding of this newWeld (Lazear 2000 ). As the above
quote suggests, the claims are ambitious and include providing answers to ques-
tions such as, ‘when is it optimal to lay oVworkers?,’ ‘what ratio of beneWts to
wages maximizes the interests of both workers andWrms?,’ ‘how much authority
ought a worker be given?,’ and ‘what monetary incentives produce high levels of
teamwork?’ Also, a measure of its success is its backwards integration into conven-
tional labor economics textbooks (e.g. Bosworth et al. 1996 : chs. 18 – 21 ).
The application of incentives is illustrated by the worker eVort/productivity
problem. Drawing on the principal–agent paradigm,Wrst elaborated to analyze
the incentives for managers to act in the shareholders’ interests (Jensen and
Meckling 1976 ), personnel economics deWnes the employer as the principal and
the worker as agent. The root of the problem is the conXicting, self-interested
objectives of principal and agent; the principal aims to maximize returns to labor
costs and the agent wishes to maximize utility, where wage is a good and eVort a
bad. As in HRM, personnel economics recognizes that eVort is rarely observable.
Conditions of uncertainty and imperfect information (modeled variously as asym-
metric information or as symmetric ignorance) make the contract incomplete,
generating risks for both parties. Incentive theory, in this context, aims to devise
contracts that maximize worker eVort at the least cost to theWrm. Several pre-
scriptions for HRM policy follow. For example, aWrm may use expensive systems
of screening where eVort is hard to determine to identify employees whose
individual output is less than their cost (if the scale of losses associated with less
productive workers warrants the practice). Or, aWrm may use output-based pay,
which both induces workers who are ineYcient to quit (because pay is low) and
provides direct incentives to productive workers to produce more. Another option
presented is to widen the spread of the internal wage structure, creating higher
eVort levels due to the so-called tournament model, which states that the
higher the spread the more a given worker exerts eVort to obtain promotion to
the higher-paid position. Finally, where eVort is diYcult to observe (or to deWne),
and screening is prohibitively costly, steep seniority wage proWles can be designed
that create higher incentives for workers not to shirk, particularly if combined with
relatively large penalties for substandard worker performance.
Certain assumptions underpin this application of incentive theory. First, the
worker and the employer are rational, self-interested, maximizing agents. Second,
equilibrium conditions prevail. And thirdly, constrained maximizing behavior by
workers andWrms generates eYciency (Lazear 2000 ). Given these assumptions,
HRM scholars drawn from the softer social sciences may be forgiven for suspecting
economists to have a profoundly unsophisticated approach to human motivation.
economics and hrm 73