Performance Evaluation Inflation

*Russell Golman
Social and Decision Sciences, Carnegie Mellon University

Sudeep Bhatia
Social and Decision Sciences, Carnegie Mellon University

     Full text: PDF
     Last modified: March 10, 2011
     Presentation date: 03/13/2011 10:15 AM in NH 1140, Session C
     (View Schedule)

Abstract
We show that a surprisingly simple mechanism can account for subjective performance evaluation inflation. When a manager observes noisy signals of employee performance and the manager strives to produce accurate ratings but feels worse about unfavorable errors than about favorable errors, the manager's selfishly optimal ratings will be biased upwards. Both the uncertainty about performance and the asymmetry in the manager's utility are necessary conditions for performance evaluation inflation. Neither factor alone generates any inflation. Moreover, the extent of the bias is increasing in the variance of the performance signal and in the asymmetry in aversion to unfair ratings. This result suggests that performance appraisals based on well-defined unambiguous criteria will have less bias. Additionally, we demonstrate that employer and employee can account for biased performance evaluations when they agree to a contract, and they can use relative performance contracts to do so even when they are unaware of the extent of the bias.