Economic Analysis for HR Professionals

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FFormer employment lawyer and author Jathan Janove writes for SHRM online on how to inject more humanity into HR compliance. He welcomes your questions and suggestions for future columns. Contact him at the email address at the end of this column.

Perhaps more than anything else, the University of Chicago is known for offering and studying economic theories, such as the so-called Chicago School of Economics. When I attended law school there, I received an immersion in economic theory. I had studied English before starting law school; studying there was like learning to swim by being thrown into the deep end without water wings or nose plugs.

Yet years later as an employment lawyer and later as an HR coach and consultant, I learned the value of using the basic principles of economic analysis to help HR to step up his game.

Probability x Magnitude = Value

Previously, I’ve written about Solomon’s paradox – the notion that our decision-making tends to be flawed because we don’t consider enough information, we make too many assumptions, we limit our options, and we impose too much stiffness.

In the 18th century, mathematician Daniel Bernoulli proposed a solution to Solomon’s paradox. He said the key to happiness was making good life decisions. This meant, he claimed, assessing probability of the result multiplied by magnitude of result. That would give you the present assess of any action contemplated.

Bernoulli’s formula underpins modern behavioral economics. When considering an action, the rational actor will weigh the likelihood of the costs, risks, and benefits multiplied by their magnitude. The stock with the highest overall current value will be chosen.

In economic terms, it could be choosing between a 10% chance of winning $1,000 or a 1% chance of winning $1 million. In the workplace, it can be a choice between firing a problematic employee or keeping the worker employed.

Option creation

Another principle of economic analysis that I find useful is a method of identifying options. You start at one end of the risk/reward spectrum, move to the other end, then work towards the middle. Imagine bookends where you end up with a volume in between.

At the University of Chicago, we were taught three terms:

  • “Risk averse.” It means, “I don’t want to take any risks and will pay a premium so I don’t have to worry about the downside.” (Among other things, risk aversion is a big boon to the insurance industry.)
  • “Prefer the risk.” This means that while holding the dice, you say, “Don’t worry about the rent money, honey.” I feel good with this one!
  • “Neutral risk.” This is where you carefully assess the intended action in terms of the likelihood and magnitude of the costs, risks and benefits.

Economic analysis applied to HR

Here is an example familiar to the most experienced HR professionals. After years of dithering, management finally reaches breaking point with a problematic employee. Even though management has never addressed the issue when and how it should have, they want the employee to leave “today!”

Sound familiar to you, HR pros?

You might say, “That’s ridiculous. The case is a mess, and we’re most likely going to be beaten in court.

Your analysis is probably sound, but I’m afraid it doesn’t promote good HR/management relations.

Another approach would be to use economic analysis. “OK, management,” you say. “Let’s identify and evaluate the options.

“Option one: We fire this person today, as you are proposing. There is clearly a benefit to you in doing so. Now let’s look at the costs and risks.” (That would be the risk preference option.)

You then go the other way, risk averse: “Second option: If we want to completely eliminate the legal risk, we can keep this person on essentially permanent paid leave. use.’

“However, judging by the look of your faces, I would say that this option will incur substantial present and future business and organizational costs.”

Then you go risk neutral. “Now let’s try to identify an option that might be somewhere in between. That would be one that has business and organizational benefits but creates a claim risk that is reasonable in light of the overall circumstances.”

Conclusion

Interacting in the way I just described takes HR away from the “Department of No”, the “Department of You Can’t”, or the “Department of You Must”. It converts HR into a true business associate, merging legal compliance, loss prevention and business needs.

Watch how this approach changes the dynamic the next time you work with management on a difficult situation. Not only will the interaction be more collaborative and less confrontational, but I predict it will also allow you to hear from management earlier and more often. This is when the options are more plentiful.

Jathan Janove, JD, is the author hard-earned wisdom: True stories from the trenches of leadership (HarperCollins/Amacom, 2017). He is president of the Oregon Organizational Development Network and was named in Inc. magazine as one of top 100 leadership speakers for 2018. If you have any questions or suggested topics for future columns, write to [email protected]

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