Employee remuneration systems are often based on the wrong assumptions
Jan. 6 2011 - 4:56 am 424 views 0 recommendations
By FREEK VERMEULEN
Excerpts:
Basic assumption: they will work more if I pay them more... the price elasticity of wages.....Simply put, we tend to assume it is positive: If people make a lot of dosh per hour, we expect them to want to put in more hours. If we reduce the hourly wage, they will be less inclined to want to work many hours and, instead, prefer leisure time; catching a movie, go fishing, or crash out on the sofa holding a beer.
The slight problem is, the assumption appears to be wrong...It is actually quite likely that, in reality (which is hardly the same as economic theory), people’s price elasticity is negative: meaning, if they get paid a higher hourly wage, people start to work fewer hours…
No drivin’ in the rain: NYC taxi drivers ... A classic study on this topic was conducted by
Professor Colin Camerer and colleagues from the California Institute of Technology. They examined New York City taxi drivers –
Economic theory would now predict that taxi drivers make longer days when it is raining because then they make more money per hour. Vice versa, we’d expect that they go home early when it is sunny (to lie down in the park, play with their kids, or take up knitting – or whatever excites taxi drivers). That sounds quite logical, right? Right… The only problem being that Colin’s research pointed out that the exact opposite is true. When it is a sunny day, and taxi drivers are not getting much buck for their hour, they continue driving and make long days. Instead, when it is raining, and taxi drivers have a high hourly wage, they tend to call it a day early… They, en-masse, were doing the exact opposite of what economic theory would predict. And that is a bit of bummer for our whole remuneration system and theory, because apparently it is built on shaky grounds.
But why…?... based on a bunch of interviews with NYC taxi drivers – that people simply apply a different rule in their professional lives. They basically tell themselves, at the beginning of the day, that they have to make a certain amount of money and are then allowed to go home. And the taxi drivers continued driving till they had reached that amount. Some days, they (told themselves they) were lucky because it started raining and they allowed themselves to go home early. Other days – bummer – the sun stayed out and they had to drive longer to reach their target for the day. The vast majority of taxi drivers they interviewed uttered this logic; only one taxi driver said “drive a lot when doing well, quite early on a bad day” (the economists’ prediction), and I guess that’s simply because you always need one exception to confirm the rule.
What does this say about human behaviour? In economic terms this behaviour (“drive till I have reached a certain amount of money”) is plain irrational. As a matter of fact, Colin and colleagues computed that by only adopting the simple alternative rule “drive a fixed number of hours every day”, taxi-drivers could already enhance their income by 50-78 percent. They could increase it with 156 percent if they would just drive more hours when it is raining and less when it is sunny (which, incidentally, would also enable them to spend their leisure time in the sun, rather than inside grumbling at the rain!). Plain irrational indeed. But, as we both know, people aren’t always rational… So perhaps it is also time to rethink how to reward them differently.
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Freek Vermeulen - About Me
I am an Associate Professor of Strategic & International Management at the London Business School and author of the book "Business Exposed: The naked truth about what really goes on in the world of business" (FT Prentice Hall)
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