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August 2005 Ask a ProfessorGSB professors give guidance on the purpose of
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Q: Though the labor market has picked up, I still get a very good selection of resumes whenever I have a job opening. I worry that filling a position with someone who is overqualified will lead to problems because the person will leave when a better opportunity comes along. Should I be concerned about this?
Paul Oyer, Associate Professor of Economics:
Two concepts from labor economics shed some light on this. The first is what we
often refer to as “firm-specific human capital.” That is, in some jobs and at
some firms, people learn skills that are very specific to that employer and,
therefore, it is very costly when people leave those jobs. For example, if you
are hiring a computer programmer who must learn a proprietary computer system
before he/she can make useful contributions, you want to be cautious about
hiring an overqualified person who will take a more challenging position as soon
as it opens up. However, I think many firms overestimate the costs of turnover
because many skills are not at all firm specific. If you can hire a programmer
who will use well-known programs and be productive immediately, you do not need
to get caught in the natural tendency to obsess about turnover. Hire the person
and have a mutually rewarding relationship for as long as it lasts. Then let the
person go on his/her way.
The second useful idea, which may not be possible to apply in all cases, is to
find out if a person is truly interested in the job for the long term by getting
them to “signal” their interest. (This is an application of the idea that won
former GSB Dean Michael Spence the Nobel Prize in economics.) If you simply ask
the applicant, “Will you leave when the economy picks up?” he/she may well say,
“No, this is just the kind of job I want for the long term for these reasons,”
etc. But talk is cheap, so how will you know if the applicant really means it?
If instead you can get the person to make a costly investment, the investment
signals that the person is serious about a longer term relationship. One way to
do this, of course, is to set up a compensation scheme that rewards long tenure.
If your firm has a standard compensation structure that prevents this, an
alternative is to place some burden on the applicant. That is, make it clear you
are interested in the person but ask him/her to do something that you suspect
only someone truly interested in the job would do. This could be a sample of
work, spending lots of time getting to know people before you offer the job, or
simply waiting and letting the applicant signal interest by making sure he/she
follows up with you. At least in some cases, if you play “hard to get,” only the
right people will pursue you.
The risks and rewards of hiring overqualified applicants vary with the
circumstances. But if you do not need the person to make a big investment in the
firm and/or you can figure out a way to separate the truly interested from those
who just need some cash, hiring someone who seems overqualified can pay off.
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Q: Recently the U.S. Treasury indicted it may start issuing long-maturity bonds. You have been advocating this for years. Why?
J. Darrell Duffie, James Irvin Miller Professor of Finance:
At the recommendation of then Undersecretary Peter R. Fisher, the U.S. Treasury
eliminated its 30-year “long” bond in October 2001. The longest maturity
Treasury since that time has been the 10-year note. When the elimination of the
30-year bond was being considered, the U.S. government was running a budget
surplus, and therefore issuing less debt. There was a case to be made that,
given the liquidity advantages of large bond issues, the United States would
reduce its interest expense by focusing on bigger issues at shorter maturities.
In my view, the case for eliminating the 30-year bond was thin at that time.
At this point, with annual federal deficits in excess of $400 billion, it is
easy to make the case for reintroducing the 30-year bond. France, which issues
far less government debt than does the United States, periodically issues more
and more 30-year bonds in order to offer the marketplace long-term bonds and at
the same time garner the liquidity advantage of large issues. [In February]
France successfully issued a 50-year bond; Germany and the United Kingdom have
said that they will follow suit. There is likely to be a large unmet demand for
long-term U.S. nominal bonds, particularly in order to hedge long-term
liabilities, such as pension benefits or insurance claims. In my opinion, it
would benefit the U.S. Treasury as well as a large range of investors to
reintroduce a long-maturity Treasury bond.
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Q: Investors are encouraged to diversity their portfolios to achieve the risk-return tradeoff that is best for them individually. At the same time company managers often talk about the need to diversify the businesses within their own companies in order to lower risk. Are these conflicting ideals?
Phillip Leslie, Assistant Professor of Strategic Management:
On the face of it, yes. The desire of firms to diversify for the purpose of
risk reduction is inconsistent with shareholder value maximization. The
conventional view in economics is that managers should maximize expected profit
without heed to the risks involved, and investors choose diversified portfolios
to mitigate risk. That’s not to say there aren’t good reasons for a company to
be diversified. For example, there may be synergies between firms in different
markets that can only be exploited if there is common ownership. However,
diversification for the purpose of risk management by the company managers is
not a valid justification. Moreover, economists tend to be skeptical of such
reasoning given by firms, suspecting it to be a veil for empire building. Note
that this does not apply to private companies. If you own your own business with
a significant fraction of your wealth invested in it, diversifying your own
personal portfolio means diversifying the company.
Having said that, you may be wondering: If managers can lower the volatility of
the firm’s profits, won’t this reduce the cost of capital, which is good for
profitability and shareholders? Maybe, but there are usually much cheaper ways,
such as using financial instruments, to reduce volatility than by buying
companies or greenfield entry into new markets. Indeed, several companies, like
Cemex, are well known for their sophisticated use of financial tools to lower
their cost of capital. Before financial markets were as well developed as they
are today, it probably made more sense for firms to diversify for risk
management purposes. But these days, I would be skeptical of such reasoning.
Ask
A Professor
The editors welcome questions from readers that provide an opportunity to apply faculty research findings to business situations. If you have a question about your business that is brief and general enough to be of interest to other readers, please send it to “Ask a Professor” in care of gsb_newsline@gsb.stanford.edu. We will seek appropriate expertise but can only provide answers to the questions that are selected for publication. Please also include your name and class affiliation.
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