Challenges of Employee Retention.pdf

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Management Research NewsChallenges of employee retention

Kevin J. Sigler

Ar tic le information:To cite this document:Kevin J. Sigler, (1999),"Challenges of employee retention", Management Research News, Vol. 22 Iss 10 pp. 1 - 5Permanent link to this document:http://dx.doi.org/10.1108/01409179910781823

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Challenges of Employee Retentionby Kevin J. Sigler

Retention of talented employees can be a source of advantage for an organisation.But there are challenges in attempting to retain these employees (Barney [1991];Wernerfelt [1984]; Pettman [1975]). In a perfect world the productive employeesare encouraged to stay within the organisation and the nonproductive poor per-formers are encouraged to leave. In fact, if it were measurable a company wouldkeep each employee 1) whose contribution produces a positive risk adjusted profitfor the firm and 2) who will also have a more positive influence on the firm thanany employee hired to replace him or her (taking into account the cost of hiring thenew employee). But because of problems such as asymmetric information it is noeasy task to carry out this goal. This article addresses the problems, costs andmethods used to retain productive employees.

Costs of Employee Retention

The loss of talented employees may be very detrimental to the companys futuresuccess. Outstanding employees may leave an organisation because they becomedissatisfied, underpaid or unmotivated (Coff [1996]), and while trying to retainemployees within the organisation they may present other challenges as well.They may demand higher wages, not comply to organisation practices, and not in-teract well with their coworkers or comply to their managers directions.

Asymmetric Information

Besides these problems asymmetric information or lack of information about theemployees performance may complicate an organisations endeavour to retainproductive employees. Without adequate information an organisation may not beable to distinguish productive workers from nonproductive ones. Employees of -ten may take credit for the successes and deflect failures to other employees. Thisis known as a moral hazard problem. In many instances companies may reward orpunish employees for an organisation outcome for which they had no impact (Kerr[1975]).

Insufficient information about employees performance may result in adverseselection by them (Grossman & Hart [1986]). The better employees may move toother organisations for better opportunities. The coworkers who cannot improve

their positions are more likely to stay. This is especially possible when due to in-adequate information outstanding performance is not rewarded. Nonproductiveand productive workers end up receiving the same or nearly the same compensa-tion and package of perks because of managements inability to distinguish tal -ented employees from the rest of the labour force in the organisation.

The problem of attempting to keep talented members of the work force is fur-ther complicated because of bounded rationality (Simon [1976]). It is another re-sult of asymmetric information where both the manager does not know theinformation for which to ask from the employee and the employee does not knowwhat to provide. Therefore, productive workers cannot distinguish themselvesfrom nonproductive coworkers.

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Volume 22 Number 10 1999

Biographical Note

Dr. Kevin J. Sigler can be

contacted at the

Department of Economics

and Finance, Cameron

School of Business,University of North

Carolina at Wilmington,

601 South College Road,

Wilmington, North

Carolina 28403 - 3297,

USA.


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Agency Costs

Even if an organisation is fortunate enough to retain talented employees, the com-pany may still have to cope with agency costs resulting from them and their col-

leagues. When information about an employees activities is difficult to gather,the employee (or agent of the shareholders) may be motivated to act in his own in-terest which may diverge from the interest of the organisation.

This divergence of interests results in costs to the organisation in the form of ex-cessive perquisite consumption, shirking of job responsibilities and poor invest-ment decision making. Jensen and Meckling [1976] explained that it is in anemployees interest to over consume perks and shirk job responsibilities of thefirm if they are not sole owners of the organisation.

Employees may also be enticed to make sub-optimal investment decisions forthe firm. Since most company employees have their wealth tied up in the organisa-

tion for which they work, employees may attempt to make investment decisionswhich are less risky than the stockholders of the firm would prefer. This is done toreduce the risk of failure by the company which protects the non-diversified em -ployee from loss of wealth. This investment strategy may also reduce the return oninvestment that the diversified owners of the firm desire (Murphy [1985]).

The employees or agents of the organisation may also use a shortsighted ap-proach in investment selection to enhance their own career chances (Narayanan[1985]). The employee can signal the labour market his superiority through the se-lection of a fast starting project which may fizzle out later for the firm (of courseby the time the true value of the shortsighted project is revealed the employee hasmoved on to a better job). This strategy may cause the firm to miss out on profit-

able long-term projects or much needed research and development.

Employees may also attempt to increase the size of the firm through acquisi-tions and project selection regardless of the effect on company profitability in or-der to increase their own power base within the firm.

Remedies to Employee Retention Problems

Incentive compensation is one method which is used to reduce the problems sur-rounding the effort to retain employees. By aligning the interests of the employeeswith the owners of the firm through pay incentives, the agency problems of exces-sive perquisite consumption, shirking and poor investment decision making may

be reduced. Incentive pay may also give the employee the incentive to stay in theorganisation, provide a competitive wage so the employee is paid fairly, and en-courage the employee to comply to organisational practices. In addition to usingpay incentives to reward the employee for reaching company goals and demon-strating loyalty to the organisation, efforts can be made by the organisation to im-prove job satisfaction. This may also increase the numbers of talented employeeswho stay in the company.

Incentive Pay

Incentive pay may consist of cash bonuses for employees upon reaching predeter-mined goals. The bonus is normally tied to accounting measures and many times

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specifically to the employees job area.

Stock ownership by the employee is another type of pay incentive. It in essencemakes the employee a stockholder of the organisation aligning the interests of the

employee with the owners. Employee stock ownership can come through re -stricted stock plans where ownership of the stock is not transferred to the em -ployee until after a specific period of time has passed or a specific goal has beenachieved. Other stock ownership by employees may come through Stock Appre-ciation Rights (SAR) or Phantom Stock plan where employees benefit if the valueof the firms stock increases. Stock options are also used to motivate employeesand reduce agency costs and retention problems. Employees have the rightthrough these options to purchase the company stock at a predetermined price.This provides employees the incentive to drive the stock price higher through theirwork effort.

But each of the pay components discussed above if included in an employees

pay package may produce other problems for an organisation. Cash bonuses aremany times based on the performance of firm which is measured using accountingnumbers. This may motivate an employee to manipulate the timing of revenuesand expenses over which they have control to maximise their own pay out (Healey[1985]). Cash bonuses may also focus the employee on short-term performance ofthe firm at the detriment of long-term performance.

Compensation in the form of company common stock may have the draw backof not being specific enough to truly motivate the employee to work hard, stay inthe organisation and comply with practices (Larcker [1983]}. For instance, thestock of the company is driven in large part by how well the overall market forstocks performs. Therefore the price of most company stock moves up and down

in value depending on the overall economy over which the employee has no con-trol. Also since the stock price is not tied solely to the employees job, an em-ployee may ride the efforts of one or a few colleagues who make decisions and putforth effort which increase share value.

One way to reduce the shortcomings of each pay component is to pay companyemployees with a combination of bonuses, stock pay out and salary. An adequatebase salary allows the organisation to compete for employees in the labour marketeffectively. Including stock ownership as a part of an employees compensationpackage offsets the problems of accounting manipulation by company employeesand also may motivate employees to focus on long-term performance of the firm(using restricted stock). Cash bonuses based on specific performance of the em-

ployee motivates the worker not to sit back and ride the coattails of productive col-leagues. This may be the reason executives as well as other employees in manyorganisations have complex pay packages.

Job Satisfaction

Besides using compensation, retaining talented employees may also be accom-plished through improving their job satisfaction. Management can insure talentedemployees are given autonomy in their job functions and are given meaningful as-signments, allowing them to be involved in the decision making for their area ofexpertise. Pleasant working conditions can also entice productive workers to stayin their organisation and not look elsewhere. In addition, offering these talented

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employees training to keep them current on their job functions and allowing themto learn new skills can also be utilised to improve employee satisfaction with theorganisation (Rice, Gentile, & McFarlin [1991]).

Pay incentives will help align the employees interests with those of the organi-sations owners and efforts to improve job satisfaction through employee auton-omy, training, and pleasant working conditions will help retain talentedemployees. But because of asymmetric information it may be difficult to encour-age poor performers to leave the organisation. Better monitoring of employeesthrough audits and surveillance may help distinguish productive from nonproduc-tive employees.

But even if an organisation can distinguish talented employees from poor per-formers it still needs to assess the impact the employee is making on his cowork-ers. Employees though talented may have a negative impact on the otheremployees and reduce the productivity of those around them. Or, talented employ-

ees who do not buy into the mission of the firm may influence others to questionthe direction of the organisation and therefore produce a negative work atmos-phere. Methods to assess the poisoning impact of these kinds of employees mustbe utilised by management and efforts to remove these types of workers must beconsidered in conjunction with pay incentives and improving job satisfaction.

Conclusion

Retaining talented productive employees and eliminating poor performing em-ployees is essential to the long run success of an organisation. But there are prob-lems such as adverse selection, moral hazard and agency costs associated withreaching this goal. Incentive compensation and increasing employee job satisfac-

tion may be useful in addressing the challenges surrounding employee retention.

References

Barney, J.B., 1991, Firm Resources and Sustained Competitive Advantage,Journal of Management, Vol. 17, pp.99-120.

Coff, R.W., 1997, Human Assets and Management Dilemmas: Coping with Haz-ards on the Road to Resource-Based Theory,Academy of Management Journal,Vol. 22, pp.374-402.

Grossman, S.J. & O.D. Hart, 1986, The Costs and Benefits of Ownership: A The-

ory of Vertical and Lateral Integration,Journal of Political Economy, Vol. 94,pp.691-719.

Healey, P., The Effect of Bonus Schemes on Accounting Decisions,Journal ofAccounting and Economics, April 1985, pp.85-107.

Jensen, M. & W. Meckling, 1976, The Theory of the Firm: Managerial Behavior,Agency Costs and Ownership Structure, Journal of Financial Economics,pp.305-360.

Kerr, S., 1975, On the Folly of Rewarding A While Hoping for B,Academy ofManagement Journal, Vol. 18, pp.769-782.

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Larcker, D., The Association Between Performance Plan Adoption and Corpo-rate Capital Investment, Journal of Accounting and Economics, April 1983,pp.3-30.

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Narayanan, M., Managerial Incentives for Short Term Results,Journal of Fi -nance, December 1985, pp.1469-1484.

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