Costs and benefits of discretion in performance evaluation and patterns of bias

Abstract

This paper investigates incentive effects from subjective performance evaluation (SPE) in an agency setting. An employee (agent) is evaluated by his superior (principal) via a subjective, potentially biased, performance report. We assume that this subjectiveness in evaluation affects the utility of both players, causing costs from biasing the report to the principal and benefits (costs) from over- (under-) evaluation to the agent. If the superior chooses the reporting bias sequentially optimal, we find that benefits from subjective, as opposed to objective performance measurement, do not outweigh its costs. If, in contrast, the supervisor is able to commit to an ex ante optimal bias choice, SPE can be beneficial if the agent’s preference for over-evaluation is sufficiently strong. While a centrality bias arises independent from the supervisor’s ability to commit, a leniency bias results only along with an ex ante optimal bias.