Economic Analysis for HR Professionals

Jathan Janove, J.D. By Jathan Janove, J.D. June 20, 2022
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Economic Analysis for HR Professionals

Former employment attorney and author Jathan Janove writes for SHRM Online on how to inject greater humanity into HR compliance. He welcomes your questions and suggestions for future columns. Contact him at the e-mail address at the end of this column. 

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

Yet years later as an employment law attorney and then as an HR coach and consultant, I came to appreciate the value of using basic principles of economic analysis to help HR step up its game. 

Likelihood x Magnitude = Value 

Previously, I wrote about the Solomon 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 rigidity. 

In the 18th century, mathematician Daniel Bernoulli offered a solution to the Solomon Paradox. He stated that the key to happiness was making good life decisions. That meant, he asserted, assessing likelihood of outcome multiplied by magnitude of outcome. This would give you the present value of any contemplated action. 

Bernoulli's formula underpins modern behavioral economics. When contemplating an action, the rational actor will evaluate the likelihood of costs, risks and benefits multiplied by their magnitude. The action with the highest overall present value will be chosen. 

In economic terms, this might be choosing between a 10 percent chance of winning $1,000 or a 1 percent chance of winning $1 million. In the workplace, it might be choosing between firing a problematic employee versus keeping the worker employed.

Creating Options 

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

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

  • "Risk-Averse." This means, "I don't want to take any chances and will pay a premium not to have to worry about the downside." (Among other things, risk aversion is a great blessing to the insurance industry.)
  • "Risk Preferer." This means that while holding the dice you say, "Don't worry about the rent money, honey. I feel good about this one!"
  • "Risk-Neutral." This is where you carefully assess contemplated action in terms of likelihood and magnitude of costs, risks and benefits. 

Economic Analysis Applied to HR 

Here's an example familiar to most experienced HR professionals. After years of procrastination, management finally hits the breaking point with a problematic employee. Even though management never dealt with the problem when and how it should have, it wants the employee gone "today!"

Sound familiar, HR professionals? 

You could say, "That's ridiculous. The file's a mess, and we'll most likely get beat up in a court of law."

Your analysis is probably sound, but I'm afraid it's not going to promote good HR/management relations.

Another approach would be to use economic analysis. "OK, management," you say. "Let's identify and assess options.

"Option one: We fire this person today as you propose. Clearly there's a benefit to you in doing so. Now, let's look at the costs and risks." (This would be the risk preferer option.)

You then go in the other direction, risk-averse: "Option two: If we want to entirely eliminate legal risk, we can keep this person on essentially permanent paid vacation. To my knowledge, there's little risk of being sued for 'wrongful continued employment.'

"However, judging by the looks on your faces, I'd say this option will have substantial present and future business and organizational costs."

Next, you move to risk-neutral. "Now, let's try to identify an option that might be somewhere in between these two. It would be one that has business and organizational benefits yet creates claim risk that is sensible in light of overall circumstances."

Conclusion

Interacting in the way I just described moves 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 collaborator, merging legal compliance, claims prevention and business need.

Watch how this approach changes the dynamic the next time you work with management on a tough situation. Not only will the interaction be more collaborative and less adversarial, but I predict it also will result in you hearing from management sooner and more often. That's when options are more plentiful.


Jathan Janove, J.D., is the author of Hard-Won Wisdom: True Stories from the Management Trenches (HarperCollins/Amacom, 2017). He is president of the Oregon Organization Development Network and was named in Inc. magazine as one of the Top 100 Leadership Speakers for 2018. If you have questions or suggestions for topics for future columns, write to jathan@jathanjanove.com.

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