Strategic human resource management (SHRM) aims to leverage a firm’s human resource base to create economic value for an organisation. In order to create economic value, firms must understand the actual behaviour of economic agents. Behavioural economics aim to understand the real, as distinct from theoretical, behaviour of humans when making economic choices. Hence, behavioural economics is central to a firm’s implementation of SHRM. However, despite the strong theoretical relationship between SHRM and behavioural economics, the actual research on the use of behavioural economics is fragmentary and inadequate.
This article traces the roots of behavioural economics to prospect theory and identifies the basic concepts—comparison to a reference point, risk aversion and loss aversion—underlying prospect theory. The applications of these basic concepts in HRM are elucidated and the current research linking behavioural economics to HRM is presented. With respect to HRM, the current research on behavioural economics is most relevant to compensation management. Based on the discussion regarding application of behavioural economics in HRM, the article concludes by identifying future areas of research in the application of behavioural economics to HRM and scope for mutual exchange of knowledge between researchers and practitioners.
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