Task‐Specific Human Capital and Organizational Inertia

• DOI: http://doi.org/10.1111/jems.12142
• Author: Otto H. Swank,Josse Delfgaauw
• Date: 01 September 2016
• Published date: 01 September 2016

Task-Specific Human Capital and Organizational

Inertia

JOSSE DELFGAAUW

Erasmus University Rotterdam and Tinbergen Institute

delfgaauw@ese.eur.nl

OTTO H. SWANK

Erasmus University Rotterdam and Tinbergen Institute

swank@ese.eur.nl

Employees’ incentive to invest in their task proficiency depends on the likelihood that they

will execute the same tasks in the future. Changes in tasks can be warranted as a result of

technological progress and changes in firm strategy as well as from fine-tuning job design and

from monitoring individuals’ performance. However, the possibility of a change in tasks reduces

employees’ incentive to invest in task-specific skills. We develop a simple two-period principal–

agent model showing that some degree of inertia benefits the principal. We then analyze how

organizations can optimally combine several policies to approach the optimal degree of inertia.

In particular, we consider the optimal mixture of (abstaining from) exploration, managerial

vision, organizational task-specific investments, and incentive pay. Our analysis yields testable

predictions concerning the relations between these organizational policies.

1. Introduction

One of the best-known virtues of competition is that it provides incentives to firms

and individuals to search for new opportunities to improve upon current practice. For

Schumpeter, this process of creative destruction is an essential feature of capitalism.

In this paper, we argue that although the continuous search for new opportunities is

widely regarded as a social blessing, within firms it provides a challenge when workers

can invest in task-specific productivity. In an environment where workers anticipate

that current practices or activities are possibly replaced by new tasks, workers may be

reluctant to invest in their aptitude to perform their current activities.1This reduces

their productivity in the current task, which in turn makes it even more likely that

management decides to switch to a new task assignment. When workers’ investment

in task-specific human capital is sufficiently important, firms benefit from reducing the

probability of changes in future task assignments. In this paper, we analyze when and

how organizations can induce some degree of inertia.

In the management literature, organizational inertia is a much-discussed phe-

nomenon (March, 1981, 1991; Hannan and Freeman, 1984; Rumelt, 1995; Schrey¨

ogg and

Sydow, 2011 and the references therein). Organizations tend to develop procedures and

We gratefully acknowledge comments and suggestions by the Co–Editor, two Referees, Daniel Ferreira, Eric

van den Steen, Michael Waldman, and participants at the 2014 POEK conferencein Cologne.

1. A key feature of our model is that employees’ task proficiency increases in experience with performing

the task. Evidence on this abounds, see Lance et al. (1989) for jet engine mechanics, Schmidt et al. (1986) for

several military occupations, Waldman et al. (2003) in health care, Jovanovic and Nyarko (1995) for various

other settings, and Quinones et al. (1995) for a meta-analysis.

C2015 Wiley Periodicals, Inc.

Journal of Economics & Management Strategy, Volume25, Number 3, Autumn 2016, 608–626

Task-Specific Human Capital 609

routines that, once established, are hard to change fundamentally (Nelson and Winter,

1982). When employees have vested abilities and knowledge, they may resist changes

that reduce the value of their specific skills (Levitt and March, 1988; Rumelt, 1995).

Rigidity and inflexibility are typically seen as inherently bad for organizations, as it lim-

its organizations’ response to changes in the environment and technology (March, 1991;

Leonard-Barton, 1992; Ford et al., 2008). In contrast, Hannan and Freeman (1984) argue

that reliable and accountable organizations have an edge in competitive environments.

This favors organizations that develop a set of routines generating stable outcomes,

which become a source of inertia. We argue that organizations can benefit from culti-

vating some degree of inertia, exactly because it gives employees incentives to invest in

skills specific to their current tasks.2

In this paper, we develop a simple two-period principal-agent model where the

agent’s first-period effort also has a payoff in the second period, unless the first-period

task is replaced in period 2. In period 1, the principal can engage in exploration of

an alternative task. This yields information on the productivity of an alternative task,

which can be more productive in period 2 than the initial task (despite the first-period

investment). In this setting, the principal suffers from a time-inconsistency problem: she

would benefit from commitment to a rule that maintains the initial task for a range of

tasks’ relative productivities where replacement is optimal ex post. This commitment is

costly in terms of suboptimal second-period task assignment. However, it benefits the

principal through an increase in the agent’s effort, spurred by the increased probability

that this effort also enhances second-period performance. Credibility of commitment

to such a rule, however, requires verifiable information on tasks’ relative productivity,

which is typically not present.3

Our main contribution is that we extend the base model to analyze how orga-

nizations can optimally combine several policies that alleviate the time-inconsistency

problem described above. In particular, we consider the combination of (i) abstaining

from exploration, (ii) managerial vision, (iii) organizational task-specific investments,

and (iv) incentive pay. We study how these policies interact and when a particular

combination of policies is most effective. This yields testable predictions regarding the

patterns of implemented policies across organizations.

Our base model is close to Rotemberg and Saloner (1994), where an employee must

invest in generating strategy-specific projects and receives a bonus if his project is im-

plemented by the principal. The cost of the bonus induces the principal to ex post discard

projects that are ex ante efficient. This, in turn, reduces the employee’s incentive to exert

effort. In our model, the principal and the employee have aligned preferences regarding

project/task choice ex post, but this does not affect the principal’s time-inconsistency

problem in the base model. Rotemberg and Saloner (1994) show that firms may ben-

efit from a commitment not to (attempt to) generate alternative projects, that is, from

a commitment to a narrow business strategy. This result carries over to our setting:

strategically abstaining from exploration can be beneficial for the firm, in particular in

2. In the literature on organizational learning and routines (March, 1981; Nelson and Winter, 1982) it is

emphasized that routines are often changed incrementally. Such incremental changes will typically not affect

employees’ tasks and, hence, are not considered in this paper. The same holds for small changes in product

design or marketing strategy.Using Hannan and Freeman (1984)’s hierarchy of organizations’ inflexible core,

changes in organizational goals, forms of authority,and core technology would affect employees’ tasks more

strongly than changes in marketing strategy.

3. Boyer and Robert (2006) consider a similar setting, assuming the firm can commit to ignore profitable

alternative projects.