People Management Y - RBA · PDF filePeople Management Course Code 204 ... that ‘human...

DO NOT COPY

84

RETAIL BANKING II

RETAIL BANKINGACADEMY

204.People Management

Course Code 204 - People Management

DO NOT COPY

85© Retail Banking Academy, 2014

RETAIL BANKING II


Course Code 204People Management

Introduction

In this introduction, we set the stage for human resource management (HRM) as one of the most important and valued functions in any organisation, and especially for a ‘people business’, such as a bank. In a real sense, everyone is in HR. There is a saying:

HR is too important to be left only to the HR department

HRM is a valued asset and not just a function. This is an important distinction that will be discussed later in this introduction. In addition, we describe a bank as a people business. A full development of this idea is presented in Chapter 1.

The traditional definition of HRM is found, for example in Bratton and Gold*, where it is stated that ‘human resource management is a body of knowledge and a set of practices that define the nature of work and regulate the nature of employment.’

This definition seems to place most emphasis on hiring practices, equity laws, diversity issues, performance evaluation, compensation and rewards system etc. This is a necessary function of HRM but not a sufficient one. Modern models of HRM have endeavoured to place HRM as key to delivering organisational strategy. First we describe the Harvard model† below.

a) The Harvard Model of HRM

This is an original model in HRM and has initiated debate about the importance of HRM in an organisation and has led to other models described below.

The Harvard model leads to four policy functions of HRM. These are:

1. Human resource flows – recruitment, promotion, career planning, appraisal and assessment.

* J. Bratton and J. Gold, Human Resource Management: Theory and Practice, 2nd edition† The Harvard model of HRM is found in M. Beer, B. Spector, P.R. Lawrence, D.Q. Mills, and R.E. Walton, ‘A Conceptual View of HRM’, Managing Human Assets, Free Press (1984)


DO NOT COPY

86

RETAIL BANKING II


The key objective here is to achieve long-term commitment on the part of employees to achieve a long-term focus.

2. Reward systems – compensation and rewards, e.g., performance shares, employee stock options etc. The key objective here is to achieve long-term employee engagement and to align the long-term interests of employees with all stakeholders.

3. Employee influence – delegation of responsibility and accountability, decision-making authority etc. The key objective here is to develop managerial competence to facilitate human resource productivity. This competence element may be seen as a forerunner to Prahalad and Hamel’s (1990) core-competence model* in the sense that human resource management is a core competence. Note that this view is also aligned with Porter’s five-diamond model† of competitive advantage.

4. Work systems – definition and design of work function and ensuring that the right person is matched with the right function. The key objective here is to ensure there’s a good fit between individuals and their function and that the right people are promoted. Achieving employee satisfaction results in increased levels of productivity.

Some experts have criticised the Harvard model on the basis that it is prescriptive and lacks strategic relevance. The Warwick‡ model developed by Hendry and Pettigrew is usually seen as a solution to this problem. Some experts believe that the Harvard model of HRM is based on two fundamental economics and corporate-finance points of view. The first is the resource-based view (RBV) in microeconomics to which we referred above. The RBV asserts that a firm can achieve above-average rates of return§ on its investment by optimally managing all its resources with the objective of achieving long-term competitive advantage. The pathway to this long-term objective is the creation of differentiated skills and human capital that will be de facto hurdles for its rivals.

The main point is that differentiated skills are costly for rivals to duplicate or imitate. This concept is simple but instructive. Microeconomics states that a low-level supply of a product or service that consumers want will lead to a high price and so create economic profits for the company. As put forward by Wade and Hulland,¶ long-term value is achieved by ensuring that (see diagram on the following page) all resources are optimally leveraged.

* C.K. Prahalad, and G. Hamel, ‘The Core Competence of the Corporation’, Harvard Business Review. Vol 68, No 3, (1990).† M.F. Porter, ‘Competitive Advantage: Creating and Sustaining Superior Performance’. Free Press (2004).‡ C. Hendry, A. Pettigrew, ‘Human Resource Management: An Agenda for the 1990s’. International Journal of Human Resource Management. Vol 1, No 1 (1990).§ M. Wade, and J. Hulland, ‘The Resource-Based View and Information Systems Research: Review, Extension, and Suggestions for Future Research’, MIS Quarterly, 28, 1, March (2004).¶ Ibid.


DO NOT COPY


RETAIL BANKING II


Sustainable Competitive Advantage

Low Degree ofSubstitution

Scarcity of Resources

Above-AverageReturn on

Investment

Low Mobility

Low Imitability

Retail Bank Business

People

Balanced Score Card

Engaged Sta�

Via E�cient Process

Process

Customer

Financial

Create Customer

Satisfaction

Pro�tability

204.1: Acquiring a sustainable competitive advantage

The main source of competitive advantage that will differentiate one bank from another is ‘people skills’, which are manifested in employee engagement leading to customer satisfaction. As stated by Mervyn King*, outgoing governor of the Bank of England, with many banks offering similar or identical products and pricing, the thing that distinguishes one bank from another is the level and quality of service it provides to its customers.

The Wade and Hulland (2004) model described above shows that mobility of key resources such as human capital is a huge risk for a people business such as banking.

HRM has a key role in creating an environment where employees are engaged, and so reducing likelihood of mobility of differentiated human capital.

The second foundation for HRM is derived from corporate finance. In this theory, HRM has an important role in constructing compensation and rewards systems so as to align the interests of employees with those of other stakeholders. Of course, compensation systems and rewards systems must be based on fair and equitable criteria. But there is another strategic reasoning and it is summarised as follows:

The effects of moral hazard that is manifested from the principal-agent problem† arising from the separation of control and ownership can give rise to excessive but hidden benefits to some stakeholders at the expense of other stakeholders.

Compensation and reward systems must not only be designed and implemented to achieve fair and just reward for effort at an individual level, but HR professionals must also seek to understand the strategic implications of moral hazard and the resulting agency costs of conflict.

Hence, from a HR perspective, business strategy and HRM are intimately linked for all stakeholder benefit. The notions of performance management, people development and capacity allocations all have strategic consequences for the long-term competitive advantage of the firm.

Open Question #1 What are the main differences between the Harvard Model and the Resource Based View (RBV) in their respective approaches to people management?

* Mervyn King. Back Office and Operational Risk: Symptoms, Sources and Cures. Harriman House, (2009).† We have described, in great detail, the implications for corporate governance and ethics that arise from the principal-agent problem that exists in the modern corporation.


DO NOT COPY

88

RETAIL BANKING II


Chapter 1: Retail Banking as a People Business

We begin by laying the foundations for the strategic role of human resource management in retail banking: a people business.

From an accounting standpoint, a people business is defined as one where the staff costs are a large percentage of the overall operating cost of the company. It is typical for European banks in particular to provide information about staff costs compared to overall operating costs. However, it is not a common practice for banks worldwide. We present some data on the extent of staff costs for some European banks.

In order to interpret the data presented below, it is important to note that staff costs are largely staff salaries but also include pension costs, education and training costs, external employee costs, share-based compensation costs and social security costs. Other operating costs include depreciation of property and equipment, amortisation of software, computer costs, office expenses, travel and accommodation expenses, advertising and public relations, external advisory fees (e.g., consulting), postal charges and addition (releases) of provision for reorganisations and relocations.

ING Bank (FY 2010): Staff Costs = €5,570m; Other Operating Costs = €4,093m; Staff Costs = 55.9% of Total Operating Costs.

There is a similar percentage for other European banks.

For example, personnel costs of €2,421m were 51.7 percent of total operating costs for the fourth quarter of 2010 at Banco Santander. This was a similar percentage for each quarter of 2010. An analysis of the income statement for Deutsche Bank for FY 2010 shows that compensation and benefits (€12,671m) were 54.4 percent of the total operating expenses of €23,318m.

We see that, as an average, staff costs are about 50 percent of total operating costs for European banks.

The other accounting point to make about a people business is that tangible assets are a lower percentage of total assets when compared to industrial firms. The balance sheet comprises


DO NOT COPY


RETAIL BANKING II


mainly cash and cash equivalents, financial products, investments and goodwill. The remaining important category of assets is the tangible group that includes property (e.g., branches) and equipment (e.g., IT networks, software, ATMs etc). This is an important reflection of a people business.

Finally, we come to our definition of a people business in terms of intellectual capital so that HRM takes its proper place in a bank.

What is intellectual capital?

Intellectual capital comprises three components that are defined as follows:

Human Capital Human capital is defined as knowledge, skills and experience that employees possess and take with them when they leave the bank at the end of the working day.

Structural Capital Structural capital is defined as the knowledge and skills that stay within the firm. It comprises organisational routines, procedures, systems, cultures and databases.

Relational Capital Relational capital is defined as all resources linked to the external relationships of the firm – with customers, suppliers or partners in research and development.

Note that human capital is the most important component of intellectual capital. But, crucially, it goes away when the employee leaves at the end of the day. Recall that in order to generate long-term (sustainable) competitive advantage, core skills and expertise as embodied in human capital must be relatively immobile. This is the first challenge of HRM we have identified. HR professionals must implement policies that increase the likelihood that employees are engaged with the bank so that mobility is reduced to a minimum. This is a core function of HRM and has a bearing on its sustainable competitive advantage. A firm can easily lose its competitive advantage if key employees leave for rival firms. Economic profits will be negatively affected.

The first key role of HRM is to create policies that generate employee engagement

In addition, it is noteworthy that intellectual capital is not only human capital. Of course human capital is important and predominant. But the other components must be simultaneously enhanced. Let us see the main reason for this statement.

Structural capital comprises the assets of the bank that do not leave at the end of the day but reside within the bank. These assets include information technology (IT) infrastructure, proprietary customer databases, organisational design and organisational culture.

Human capital skills and expertise cannot be leveraged into an optimal manner for the interests of all stakeholders in the bank unless there is an organisational structure and culture that permits this to happen. A bank can employ the smartest people with all the functional expertise possible or it can set up and implement an enlightened training and development programme. But this will not lead to long-term (or even short-term) value creation unless the bank has an organisational structure that is not oppressive and stifling and a culture that is ethical. Organisational structure and culture must permit human capital flows (refer to the Harvard Model in the introduction) that lead to the creation of innovative products that serve customer needs. A poorly designed structure or a culture with no moral standing will reduce human capital to the status of a wasting asset. This sets up another key role of HRM.

The second role of HRM is to create policies that generate human resource flows – via knowledge management


DO NOT COPY

90

RETAIL BANKING II


The final component of intellectual capital is relational capital or social capital. An important part of relational capital is customer engagement (or strong loyalty).

HRM has a strategic role in a bank (as in any other people business) where assets in the balance sheets are largely people-generated and the key asset (people) is not explicitly stated, but rather appears as a large expense in the income statement. It is no wonder that senior management of people businesses seek cost reduction by layoffs. But they are missing the impact on the balance sheet where most assets are people-derived. As pointed out by Barber and Strack,* “The fact that most companies don’t own their employees, as they do their capital assets, is why methods for valuing human on the balance sheets are so torturous.”

An interesting perspective is found in an article in the Sloan Management Review, Winter 1998, by Dave Ulrich. He defines intellectual capital = Competence x Commitment. The Ulrich equation clearly summarises the link between human capital and employee engagement.

This chapter shows that HRM has two key roles (so far):

• Implement policies to generate employee engagement so as to reduce the mobility of core competencies – an important factor to generate sustainable competitive advantage.

• Implement policies that sustain an organisation structure and culture that foster knowledge management.

But how can the HR professional accomplish these tasks? What are the drivers of employee engagement? We answer these questions in the next chapter.

Open Question #2 What are the implications of the Intellectual Capital Model for People Management?

* Barber and Strack, ‘The Surprising Economics of a People Business’, Harvard Business Review, (June 2005).


DO NOT COPY


RETAIL BANKING II


Chapter 2:HRM and Financial Performance

Does HRM contribute to the bottom line of a bank’s income statement? In simple words, does HRM help to create profits? If the answer is yes, then how is this done? What are the logical connectors?

Evidence in the professional and academic literature states the link between HRM and the bottom line is via employee engagement. But what is employee engagement? Harter, Schmidt and Hayes* define employee engagement as “the individual’s involvement and satisfaction with, as well as enthusiasm for work”. This definition incorporates the employee’s satisfaction with work, some degree of organisational attachment and an intention to stay with the company. Lanphear† defined employee engagement as “the bond employees have with their organisation”; that “when employees really care about the business, they are more likely to go the extra mile”.

Wellins and Concelman‡ call employee engagement “the illusive force that motivates employees to higher levels of performance”.

It seems that employee engagement is two sides of the same coin: On one side of the coin is the employee who is best equipped with the knowledge, skills and experience to perform the function; on the other side of the coin is an employee who is highly motivated to carry out the function.

Here are the two main questions of this chapter:

• If employee engagement is important, then why?

• If employee engagement is important, then how to achieve it?

* J. K. Harter, F. L. Schmidt, and T. Hayes, “Business-Unit-Level Relationship Between Employee Satisfaction, Employee Engagement, and Business Outcomes: A Meta-Analysis”, Journal of Applied Psychology, 87(2), (2002). † S. Lanphear, “Are Your Employees Highly Engaged?” Credit Union Executive Newsletter, 19, 1-2. Credit Union National Association, US (2004).‡ R. Wellins & J. Concelman, “Creating a Culture for Engagement.”Workforce Performance Solutions, 2005, <www.WPSmag.com>.


DO NOT COPY

92

RETAIL BANKING II


There is significant evidence that employee engagement is positively correlated with employee productivity and with customer satisfaction (see, for example, Buckingham and Coffman*, and Coffman and Gonzalez-Molina†). This is also found by Barber and Strack (Harvard Business Review, June 2005) who demonstrate that employee engagement is correlated with economic profit, a source of shareholder-value creation.

Now that we see why employee engagement is important – it leads to higher levels of employee productivity; what we want to know is the link between employee productivity and value creation.

An article in the Harvard Business Review (June 2005) by Barber and Strack titled, “The Surprising Economics of a People Business”, shows that economic profit is positive if average employee productivity exceeds average employee cost.

The traditional way of calculating economic profit for a company is as follows:

Let us assume that a manager invests $100 in his/her business unit and, at the end of the year, the total value of the investment is $110. The initial investment of $100 is called investment capital (IC). From an accounting point of view, there is a profit of $10 or a return on investment (ROI) of 10 percent. But this is an overstatement of the profit, since we did not take into consideration the cost for the money that is invested. This is called the cost of capital (COC). Assume that cost of capital is eight percent. This means the profit is only two percent or $2 on the investment of $100. This is called the economic profit. Here is a formal definition:

EP = (ROI – COC) * IC where EP = economic profit, ROI = return on investment, COC = cost of capital and IC = investment capital.

Returning to our example, we see that EP = (0.10 – 0.08) * $100 = $2. Now we have answers to both questions posed at the start of this discussion. Let us repeat them with their proposed answers. We asked the questions:

Questions Proposed Answers

If employee engagement is important, then why?

Employee engagement is positively correlated with employee productivity (see, for example, Buckingham & Coffman and Coffman & Gonzalez-Molina).

Barber and Strack (Harvard Business Review, June 2005) demonstrate that employee engagement is correlated with shareholder value creation by creating economic profit.

If employee engagement is important, then how do you achieve it?

This is the challenge of HRM. HR professionals have to identify the drivers of employee engagement and then train managers to employ these drivers as part of steering the business.

Is there research support for the proposition that employee engagement is positively correlated with economic profit and hence shareholder value?

Supporting evidence is voluminous. For example, in 2007, Gallup analysed data from 332 organisations, representing a total of more than 4.5 million people, to calculate the link between employee engagement and earnings per share (EPS) – a determinant of share price. The research shows that public companies ranking in the top quartile of employee engagement had EPS growth of 2.6 times the rate of those that were below average.

* M. Buckingham and C. Coffman, First, Break All the Rules: What the World’s Greatest Managers do Differently (1999).† C. Coffman and G. Gonzalez-Molina, Follow This Path: How the World’s Greatest Organisations Drive Growth by Unleashing Human Potential (2002).


DO NOT COPY


RETAIL BANKING II


Standard Chartered Bank has been actively measuring, managing and improving its employee engagement since 2001, over which period the company’s value has increased by a factor of 2.5. Tim Miller, director of people, property and assurance at the bank, is clear how employee engagement drives value creation:

“There is a positive correlation between employee engagement and total shareholder return (TSR).* Specifically, companies with 60 percent to 100 percent employee engagement achieved an average TSR of 24.2 percent. With engagement scores between 49 percent to 60 percent, TSR dropped off to 9.1 percent. Companies with engagement below 25 percent suffered negative TSR.” (Hewitt Associates.)

In addition, Baek-Kyoo (Brian) Joo and Gary McLean† found a very strong correlation between (54 percent) employee engagement and a company’s average five-year TSR.

Let us summarise the logic of the presentation so far in this chapter.

We showed that:

• Employee productivity is positively correlated with economic profit and hence shareholder value creation.

• Employee engagement is positively correlated with employee productivity.

Combining these relationships, we saw that:

Employee engagement is positively correlated with shareholder value creation.

What then is the role of HRM in fostering employee engagement and hence enhancing the firm’s profitability? We have to identify the drivers of employee engagement. This will put employee engagement into real managerial actions.

Drivers of Employee Engagement that HR Should Push

There is evidence that employees become more engaged when at least three factors are in place. These are:

(a) Common direction and purpose – all employees want to be fully informed about the future direction and strategy of the company.

To support this driver, a paper by Lockwood‡ states that “research shows that the connection between an employee’s job and organisational strategy, including understanding how important the job is to the firm’s success, is the most important driver of employee engagement. In fact, employees with the highest levels of commitment perform 20 percent better and are 87 percent less likely to leave the organisation”.

Employees apparently want to know what the organisational strategy is and how they contribute to it. Relating to the components of intellectual capital, employees want to see the link between themselves (human capital) and the organisational capital of which the company’s strategy is a part.

* Total Shareholder Return (TSR) comprises two components – dividend yield and growth in the share price.† Baek-Kyoo (Brian) Joo and Gary N. McLean, (University of Minnesota), Human Resource Development Review, Vol 5, No 2, 228-257.‡ N. Lockwood “Leveraging Employee Engagement for Competitive Advantage: HR’s Strategic Role”, HR Magazine, (2007).


DO NOT COPY

94

RETAIL BANKING II


Business leaders must continually inform employees of the company’s strategy and future direction and let them know how they fit in. Furthermore, they should know what defines success.

Better still, the process of strategy development should incorporate employees at all levels with a diagonal cross-section. The Workout model developed by General Electric (GE) is highly recommended.

(b) Talent management. Employees who are most engaged are typically those whose talent matches their job function.

(c) Performance management. This is the third driver that is likely to positively create employee engagement.

Interim Summary

So far, we have concluded the following main ideas:

a) In a retail bank, an example of a people business, HRM is paramount. A people business is one where staff costs are a large percentage of total operating costs and where people-generated assets on the balance sheet forms a relatively high percentage of total assets.

b) A primary role of HR professionals is to create employee engagement, since the latter is positively correlated to employee productivity. Employee productivity is positively correlated with economic profit and shareholder value creation. The net result is that employee engagement is positively correlated to shareholder value creation.

c) We find that the main drivers of employee engagement are: - Shared common purpose - Talent management - Performance management

These issues are taken up in the next chapters.

Open Question #3 What are the main drivers of employee engagement?


DO NOT COPY


RETAIL BANKING II


Chapter 3: Compensation and Reward Systems

Compensation and reward systems serve two main purposes. The first purpose is to motivate employees, achieve retention and reduce mobility – a key determinant of sustainable competitive advantage. What is the main point here?

To achieve a strong link between compensation and rewards and performance, HR professionals must respect diversity and individual differences to best understand what people want from work. This is an attempt to understand fully what motivates the employee and to design compensation contracts to achieve the end result.

Allocate rewards to satisfy the interests of both individuals and the organisation.

Does the design of compensation systems motivate the individual employee on the way to employee engagement? If the answer is yes, what theory of motivation applies?

There are several theories of motivation in the HR literature. These theories are divided into two categories – content-based and process-based.

Content-based Theories of Motivation These theories share a common principle – human needs and how people with different needs may respond to different work situations. We examine each theory in turn.

Maslow’s Hierarchy of Needs

The core idea is that a satisfied need is not a motivator. This is called the deficit principle. An employee who feels well-paid in terms of monetary value, will probably not be motivated to a higher level of performance by an increase in salary. This employee may be motivated by non-monetary rewards that promote self-actualisation. There is also a progression principle, which means that a need at some level is not a motivator unless the need at a lower level is satisfied.


DO NOT COPY

96

RETAIL BANKING II


Level of Need Description of Need

1 Physiological

2 Safety

3 Love and Belonging

4 Self-Esteem

5 Self-Actualisation

McClelland Achievement/Power/Affiliation

People are driven by three needs: achievement, affiliation and influence.

Achievement: The need for achievement is characterised by the wish to take responsibility for finding solutions to problems, to master complex tasks, to set goals, and to get feedback on level of success. Affiliation: The need for affiliation is characterised by a desire to belong, an enjoyment of teamwork, a concern about interpersonal relationships, and a need to reduce uncertainty. Influence (power): The need for power is characterised by a drive to control and influence others, a need to win arguments, and a need to persuade and prevail. Herzberg Motivator – Hygiene Theory

This two-factor theory is based on hygiene factors and satisfier factors. Hygiene factors such as working conditions and salary are not motivators. Hygiene factors relate to the work environment. But they can be dissatisfiers when they are absent. Satisfiers are called motivators. These factors include achievement, recognition, the work itself, responsibility and advancement. They are related to what the employee does.

Alderfer Existence/Relatedness/Growth

This theory is similar to Maslow’s but there are three levels of needs.

Existence needs: Desires for physiological and material well-being.

Relatedness needs: Desires for satisfying interpersonal relationships.

Growth needs: Desires for continued psychological growth and development.

Process-Based Theories of Motivation

Adams (Equity)

If an employee believes his treatment is inequitable, compared to others, he or she will be motivated to do something about it – that is, seek equity.

There are managerial implications of this theory:

Underpaid people experience anger and overpaid people experience guilt.

So the key point is: perceptions of rewards determine motivational outcomes.

HR professionals should not underestimate the impact of compensation as a source of equity controversies in the workplace. The HR professional in trying to satisfy a need, according to any of the four needs theories stated above, must also keep in mind the perception of equity in the


DO NOT COPY


RETAIL BANKING II


workplace. Not doing this could potentially unwind the positive effects of a well-intended action.

Locke and Latham (Goal-setting)

The main principle is:

Properly set and well-managed task goals can be highly motivating.

Why? Goals provide direction for employees and clarify expectations about performance. Most importantly, goals provide a basis for feedback and exchange.

Vroom (Expectancy)

Key expectancy theory variables:

Expectancy: Belief that working hard will result in desired level of performance.

Instrumentality: Belief that successful performance will be followed by rewards.

Valence: Value a person assigns to rewards and other work-related outcomes.

Motivation is derived in a multiplicative fashion.

Motivation (M), expectancy (E), instrumentality (I), and valence (V) are related to one another in a multiplicative fashion: M = E* I* V*

Motivation is low if any of the factors are low. In particular, if the reward system is seen by the employee to be low value, then motivation and hence employee engagement is strained†

So in summary, HR professionals must understand the needs of the individual employee and not take an average point of view. Rewarding the average penalises the above-average performance and rewards the below-average performance – the classic lemons problem.

We now discuss the second purpose of compensation and reward.

The second purpose is taken from the principles of corporate finance where compensation may be utilised to mitigate agency costs.

Here are the main ideas that are relevant for HRM in the design of compensation contracts for managers.

When a manager is guaranteed a fixed compensation, e.g., salary, this manager cannot share in the value-creation activities he/she takes on behalf of shareholders. Hence, the manager might seek to share in the incremental value creation by less direct ways, for example by excessive indulgence in perquisites.‡

To reduce the loss of shareholder value, HR professionals might be encouraged to design compensation contracts (optimal contract design) so as to induce managers to take actions that will maximise shareholder value and not serve their private interests.

The idea is very simple. The board of directors wants to induce managers to take on only positive

† Calvet and Rahman (The Financial Review, Vol. 41, Issue 2, 2006) show that when employees have a concentrated level of their company’s shares in their portfolio, they view additional performance shares and stock options as having a lower subjective value than the corresponding market value. This being the case, additional employee share-option grants are not a motivator. This is a consequence of the Vroom expectancy theory (2006).‡ Perquisites are defined as follows by the SEC in the US, applying a two-part test: a) A benefit is not a perk if it is integrally and directly related to the performance of the executive’s duties b) A benefit is a perk if it confers a direct or indirect benefit and has a personal aspect. Perks are disclosed in the ‘Other Annual Compensation’ included in a company’s proxy statement. Dollar value is required to be disclosed if it exceeds $50,000 (or, if less, exceeds 10 percent of executive’s annual salary and bonus).


DO NOT COPY

98

RETAIL BANKING II


net present value (NPV) investments. Theoretically, the market value of the company’s stock should increase by the amount of the NPV. A widely cited paper by Jensen and Murphy* makes the point with respect to manager compensation:

It is not how much you pay, but how

The evidence as to whether compensation structures designed with incentive-based components, e.g., stock options, stock grants, compared to guaranteed salary, have helped to mitigate agency costs, is mixed. Jensen and Meckling† (1976) find positive evidence in favour of incentive-based contracts.

But Hall,‡ Hall and Murphy§ and Oyer and Schaefer¶ do not find evidence to support the hypothesis that incentive-based contracts lead to improved firm performance. There is also a branch of studies that has examined the incentive effects of stock-option grants. This is quite an interesting component of compensation contracts. The idea is that, as the market value of equity rises, stock-option grants will move towards being in the money. This way, managers share in value-creation activities they initiate.

But there could be a problem. Stock-option values are determined by expected total risk, whereas shareholders who are normally expected to have diversified portfolios will be more interested in systematic risk. Also, stock values could rise or fall with the general market movements. Hence, if the company’s stock has a large level of systematic risk, then the firm’s financial performance may be uncorrelated with the firm’s share price in the short run.

Empirical findings with respect to incentive effectiveness are mixed. For example, Yermack**(1995) questions the effectiveness of CEO option grants based on empirical observation while Meulbroek†† (2001), Hall and Murphy‡‡ (2000, 2002) and Calvet and Rahman (2006)§§ doubt their effectiveness on analytical grounds. Furthermore, it seems that optimal compensation contracting is a substitute for board effectiveness.

Fahlenbrach¶¶ provides evidence showing that if a firm has generally weaker governance, the compensation contract helps better align the interests of shareholders and the CEO. Similar results are obtained in previous studies, supporting the view that executive compensation is higher when the board is relatively weak.

Bebchuk and Fried*** in their paper, ‘How to Tie Equity Compensation to Long-Term Results’ recommend “To tie compensation to long-term performance, executives shouldn’t be allowed to cash out options and shares for a fixed number of years after vesting. Bonuses should not be cashed right away, but placed in a company account for several years and adjusted downward if

* Michael C. Jensen and Kevin J. Murphy, “CEO Incentives: It’s Not How Much You Pay, But How”, Harvard Business Review, No. 3 (May-June 1990).† Michael C. Jensen and William H. Meckling, “Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure”, Journal of Financial Economics, Vol. 3, No. 4: pp. 305-360, (1976).‡ B.J. Hall, “Six Challenges in Designing Equity-Based Pay”, Journal of Applied Corporate Finance, 15, (Spring 2003).§ B.J. Hall and K.J. Murphy, “The Trouble with Stock Options”, Harvard NOM Working Paper No 03-33, (2003).¶ P. Oyer, and S. Schaefer, “A Comparison of Options, Restricted Stock and Cash for Employee Compensation”, Working paper, Stanford University, (2003).** D. Yermack, “Do Corporations Award CEO Stock Options Effectively?”, Journal of Financial Economics, 39, 2003†† L. Meulbroek, “Executive Compensation Using Relative-Performance-Based Options: Evaluating the Structure and Costs of Indexed Options”, Harvard Business School Working Paper, No. 01-021 (2001).‡‡ B.J. Hall and K.J. Murphy, “Optimal Strike Prices for Executive Stock Options”, The American Economic Review, Papers and Proceedings of the 112th Annual Meeting of the American Economic Association, May 2000 and B.J. Hall and K.J. Murphy, “Stock Options for Undiversified Executives”, Journal of Accounting and Economics 33, (2002).§§ A.L. Calvet, A.H. Rahman, “The Subjective Valuation of Indexed Stock Options and Their Incentive Effects”, The Financial Review, Vol. 41, Issue 2, (2006).¶¶ Fahlenbrach. Review of Finance, “Shareholder Rights and CEO Compensation”, Volume 13, Issue 1, pp 81-113 (1999).*** Bebchuk and Fried, “How to tie equity compensation to long-term results”, Journal of Applied Corporate Finance, Volume 22, Number 1, (2010).


DO NOT COPY


RETAIL BANKING II


it turns out that the reasons for the bonus no longer hold up.”

In the above discussion, we have shown how an agency relationship between managers and shareholders can lead to significant agency costs – to the loss of value to shareholders.

This discussion shows that HRM, through the design of compensation contracts, affects the bottom line in two separate ways. The first is to stimulate employee engagement and hence shareholder value creation. The second is to mitigate agency costs by aligning the interests of shareholders and managers and so increase shareholder value.

Open Question #4 It is not only how you pay, but also the incentive effects. What are the ethical implications of this?


DO NOT COPY

100

RETAIL BANKING II


Chapter 4: Talent Management and Higher Employee Productivity

First, we quote an article from Lafferty Retail Banking Insider:

Risk of talent loss Rather than focus on the numbers of staff that banks could be hiring, Demos suggests that the banks should be focused on holding on to their best staff. Those banks that have only retained staff because of the poor job market will find that they lose talent once conditions improve.

Demos says, ‘Some banks have excellent career-planning programmes where they aggressively move people in two- to three-year shifts. These are the places that people will want to work. Old, stodgy management that believes that employees should be happy to have jobs will lose talent.’

Demos suggests that banks need to study the career development practices of organisations outside of banking. ‘When banks were embracing a new approach to customer service, they studied the Ritz-Carlton and other types of service organisations. As a result, a lot of service excellence programmes were developed around the world. The same needs to happen for talent management.’

This article describes the importance of talent management in banking. Talent management is defined as follows: Talent management is an activity that assures the flow of human capital within an organisation such that the right talent is matched with the right function at the right time.

There are two dimensions to this definition. First, HR must ensure that there is an adequate supply of core skills. The second is a matching of skills with the job requirements at a given time that will serve the long-term competitive advantage of the company.

‘Talent management, oftentimes referred to as human capital management, is the process of recruiting, managing, assessing, developing and maintaining an organisation’s most important resource – people,’ according to Khatri et al* (2010).

* Preeti Khatri, S. Gupta, K. Gulati and S. Chauhan, “Talent Management in HR”, Journal of Management and Strategy, Vol. 1, No. 1, (December 2010).


DO NOT COPY


RETAIL BANKING II


HR professionals must approach talent management in an integrated and holistic manner. According to an article by Ready and Conger* in the Wall Street Journal, “To meet the challenge, companies must rethink how they hire, train and reward their employees, placing those tasks at the heart of their business plans. In doing so, they have an opportunity to address all these separate problems with a unified plan, rather than waste time and resources attacking each of the issues individually.”

Potential Approaches for Talent Management

• In all cases, HRM actions should be in accord with the company’s business strategy. Talent management is no exception. We have already seen how the matching of talent with function in banking operations can be efficient and effective in removing bottlenecks. Talent matching complements the theory of constraints for optimal results.

• Think about the economics of a diversity programme. By this we mean that a diversity programme enlarges the supply of potential talent from which the HR professional can attract high-quality talent. This not only facilitates effective talent management, but also has other positive effects. Here are some of them:

The key point here: diversity enhances talent management, which is a driver of employee engagement.

Banks and companies in general that adopt diversity programmes are viewed quite positively by stakeholders. For example, ‘Implementation of a workforce diversity policy is a form of investment in intangible assets’ (European Commission, 2003:13). Presumably this intangible asset enhances the reputation of the bank.

There is evidence of positive side effects as well. Ng and Burke’s† study found that high achievers, as well as women and ethnic minorities, prefer to work for organisations with diversity policies, practices and values. Stuber‡ also says that some European organisations have found that diversity can be used to attract mainstream candidates, not just women and minorities.

There is also a link to corporate governance. In a recent study of Fortune 500 companies in which the potential influence of gender is measured by the percentage of women serving as members of the board, a positive influence has been found for return on equity, return on sales, and return on invested capital. Further, there is notably stronger-than-average performance at companies with three or more women board members.§‘

In addition, Erhardt, Werbel and Shrader¶ studied the role of diversity in firm performance, which they evaluate with measures of return on assets and return on investment for 127 large US companies. Diversity is measured by the percentage of women and minorities on the board of directors. They conclude that board diversity is positively associated with these financial indicators of firm performance.

We end this chapter with another excerpt from the article by Ready and Conger. It is quite revealing in spite of the evidence cited above.

* Douglas A. Ready and Jay A. Conger, “How to Fill the Talent Gap”, Wall Street Journal (15 September 2007).† Ng and Burke. “Person-Organisation Fit and the War for Talent: Does Diversity Management Make a Difference?” International Journal of Human Resource Management, 16(7), (2005).‡ M. Stuber, “Corporate Best Practice: What Some European Organisations Are Doing Well to Manage Culture and Diversity”, EuroDiversity: Managing Cultural Differences (George Simons, ed.), pp134-170 (2002).§ The Bottom Line: Corporate Performance and Women Representation on Boards, Catalyst 2007. ¶ N.L. Erhardt, J.D. Werbel, and C.B. Shrader, “Board of Director Diversity and Firm Financial Performance”. Corporate Governance, 11 (2), 2002. (An earlier version presented at The Academy of Management, Denver, Colorado, August, 2002)


DO NOT COPY

102

RETAIL BANKING II


Blind Spots

For all their talk about diversity, most business leaders tend to hire, promote and reward people who look, think and behave like them. But in today’s world, searching for your own reflection could leave you with some troubling blind spots. And it could make you miss out on tapping the talent you’ll need to win in the future.

Many companies, for instance, don’t have relationships with universities and business schools to land the best and brightest talent. There are also blind spots at home. Women, for instance, now represent approximately 40 percent of most MBA programmes. But many companies lack role models and mentors for women.

Open Question #5 What are the implications of talent management on the hiring of new employees?

Summary

This module emphasised the following key points:

• HRM is based on the resource-based view (RBV) of the firm. It is also based on the effects of moral hazard that are manifested from the principal-agent problem arising from the separation of control and ownership. This agency relationship may give rise to excessive but hidden benefits to some stakeholders at the expense of other stakeholders. HRM is vital to a people business.

• Compensation and reward systems must not only be designed and implemented to achieve fair and just reward for effort at the individual level, but HR professionals must also seek to understand the strategic implications of moral hazard and the resulting agency costs of conflict.

• A bank is a people business in that staff costs make up a large percentage of total operating expenses and the asset side of the balance sheet comprises a relatively small percentage of tangible assets. Accordingly, the central role of HRM is people management.

• We showed that HRM can have a positive effect on the bank’s income statement. Employee engagement increases employee productivity and employee productivity increases economic profit and hence shareholder value creation.

• The main drivers of employee engagement are: shared and common purpose, talent management and compensations and rewards systems.

• Compensation and rewards systems have a motivating role for the individual employee (via needs and equity theories) as well as reducing the costs arising from agency relationships.

• We showed that diversity has important economic implications. Diversity increases the pool of human capital available for the bank and hence increases the effectiveness of talent management. There is evidence that diversity programmes increase employee engagement, a driver of productivity, and hence increase shareholder value creation.


DO NOT COPY


RETAIL BANKING II


Multiple Choice Questions

1. Which of the following is categorised as human capital?

a) A company’s copyrights and patents b) Employees’ core competencies c) Customer relationship d) Relationship between bank managers and regulators

2. Which HR model views human capital as a key competitive advantage?

a) Harvard model b) Resource-based view model c) The principal-agent model d) The agency model

3. Which of the following is NOT a process-based theory of motivation?

a) Adams (Equity) b) Latham and Locke (Goal setting) c) Herzberg Motivator-Hygiene Theory d) Vroom (Expectancy)

4. Which of the models listed below is consistent with the statement that ‘if the reward system in a bank is seen by employees to be of low value, then motivation will be strained’?

a) Adams (Equity) b) Latham and Locke (Goal setting) c) Maslow Hierarchy of Needs d) Vroom (Expectancy)

5. What is not regarded as a significant driver of employee engagement?

a) Talent management b) Shared purpose c) Performance management d) Job security

6. The people equation shows that:

a) Accounting profit is positive when return on invested capital is higher than the cost of capital. b) Economic profit is positive when return on invested capital is higher than the cost of capital.c) Economic profit is positive when average employee productivity is higher than the cost of capital.d) Economic profit is positive when average employee cost is higher than average employee productivity.


DO NOT COPY

104

RETAIL BANKING II


7. The resource-based view of a retail bank states that:

a) Human capital is mobile and hence creates risk for the bank.b) Differentiated skills and competencies create a hurdle for competitors.c) Differentiated human capital can enable the bank to earn economic rents.d) The key to long-term competitive advantage for the bank is to develop human capital that is costly for rivals to imitate.

Which of the following options is/are correct statement(s)?

I: b) and d) onlyII: b), c) and d) only III: d) only IV: a), b), c) and d) only

8. Which of the following theories of motivation is best described by the phrase ‘perceptions of rewards determine motivational outcomes’?

a) Hierarchy of Needs (Maslow)b) Expectancy Theory (Vroom)c) Equity Theory (Adams) d )Theory of Goal Setting (Locke and Latham)

9. Vroom’s expectancy theory is modelled as M = E x I x V where M = Motivation, E = Expectancy, I = Instrumentality and V = Valence. If an employee has the belief that good performance will be followed by rewards, then Vroom’s theory would classify this belief as:

a) Motivationb) Expectancyc) Instrumentalityd) Valence

10. Which function is probably of less priority for HRM in a retail bank? a) Ensure that there is adequate supply of core skills. b) Create and enhance employee engagement. c) Create an environment of ethics and professionalism. d) Ensure that managers have full knowledge of labour laws.

Answers

1 2 3 4 5 6 7 8 9 10

b b c d d c IV c c d


Date post:	27-Mar-2018
Category:	Documents
Upload:	dinhdien
View:	214 times
Download:	2 times

People Management Y - RBA · PDF filePeople Management Course Code 204 ... that ‘human...

Documents