Second-ever mid-month bonus issue
Behavioral economics and investments in human resources
Behavioral New World
October 15, 2023
Behavioral economics and investments in human resources
Long-time readers will remember that the first mid-month bonus (January of this year) looked at what behavioral economics can contribute to thinking about leadership. This mid-month missive looks at what behavioral economics can contribute to thinking about investments in talent and human resources programs. “Human Resources” in organizations refers to the function that oversees talent, work relationships, and the array of systems and programs that support them.
My collaborator here is Dr. John Boudreau, a leading/eminent scholar whose contributions include an analytical approach to evaluating human resource (HR) investments and decisions. You can learn more about his work at his website: www.drjohnboudreau.com. John’s over 40-year career includes faculty positions at Cornell’s ILR School and USC’s Marshall School of Business and Center for Effective Organizations. He is a Fellow of several professional and academic organizations, has won numerous awards for his teaching and research, and consulted with organizations ranging from early-stage to global Fortune 500 companies, as well as the U.S. Navy, and NGOs. He also currently advises and mentors his five-year-old grandson.
John and I have known each other since 1977 when we shared an office during our first year of graduate school and Purdue University. It is only recently, both of us retired, that we have re-connected.
Traditionally, HR has been viewed as a “soft” discipline at least in part because it deals with human beings (rather than, say, machines or factories). Yet, as Dr. Boudreau and his co-authors have pointed out, talent, its organization, and work relationships are vital strategic resources, and they can be evaluated and enhanced using similar decision models and quantitative techniques that leaders use to value other, more tangible assets.
John and his colleagues have proposed that leaders can and should be held accountable for the quality of their decisions about talent, just as they are held accountable for their decisions about resources like money, technology, marketing, and operations. Yet movement in this direction has been slow. Barriers to the slow propagation of methodological innovations include: (a) insufficient knowledge or skills, (b) inadequate adoption of technology, (c) outdated norms, and (d) inefficient incentives.[1]
In what follows, we add to the list by considering three cognitive biases that also slow progress.
First is status quo bias. The phrase is self-explanatory. But what does the status quo have to offer? It is familiar and therefore comfortable. Changing the status quo, or at least questioning whether it should be changed, is uncomfortable and requires effort. And if the business organization is prospering, there is the “if it ain’t broke, don’t fix it” response. This may be particularly relevant to investments in talent and its organization because leaders traditionally have not been trained to understand how changing work relationships might enhance performance.
A classic example is when the organization has managers who achieve traditional business results such as productivity or financial performance but at the cost of heavy-handed practices that create high employee turnover or that reduce trust and communication with employees. Better management behaviors could reduce turnover and enhance communication, which can often lead to better workforce quality and performance, and eventually show up on the bottom line. Lacking an understanding of these relationships, managers may be tempted to think, “I’m getting good results, and high employee turnover and low morale is just an unavoidable consequence of my high-performance standards.”
Second is loss aversion. Consider an investment that returns $100 in profit to you. Feels good, doesn’t it? But suppose it lost $100 in value—that is painful. In fact, the pain of the $100 loss is estimated to be about three times the pleasure of the $100 profit.
As the example suggests, loss aversion is often described in terms of an investment. But what if we are considering investing in, for example, an employee training program? We pay money today to an (overpriced?) consultant and hope that we get more productivity or sales or whatever in the future. But the outcome is not certain. If the investment succeeds, we feel good (like the $100 profit) and might even get promoted. But if it doesn’t succeed, it was costly and there are no improvements. The pain of the outcome could be enormous (demotion?). Consequently, one might hesitate to make the investment, reinforcing the status quo bias.
What’s interesting is that these risks are essentially the same for ANY investment decision. What’s different about talent decisions is that leaders have far less sophistication and awareness of how investments in people work, compared to investments in technology, operations, etc. Financial reporting systems are far better at objectively quantifying risk and return in non-people arenas. Investments in people frequently show up ONLY as costs in the financial statements, so those costs are quite vivid. The eventual returns are often quite substantial, but because the relation between the investments and the outcomes is far more obscure, the “lost” expense is far more vivid.
Third is mistaking correlation with causation. It is not unusual for consulting firms and think tanks to report data that shows that “higher-performing companies have made more and better investments in their people, compared to lower-performing companies.” Yet at least some of this effect may be due to reverse causation: Companies that have become high-performing generate more money and other resources, giving them the freedom to try out more investments in people, even if they don’t understand how those investments work.
More compelling evidence occurs when a company can actually implement a new investment and then observe its effect on performance, but that’s often far easier for non-people investments. Leaders might compare people investments, for which experimental data is sparse, to other investments that have been treated more like experiments (such as A/B testing in marketing).
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Please recognize that this is the briefest of introductions to the “investment” perspective on HR. Interested readers can start with the footnoted publication and Dr. Boudreau’s website.
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[1] See https://journals.aom.org/doi/10.5465/amp.2022.0099?ai=vcrk&ui=3op6&af=H