Job Assignments under Moral Hazard - School of Economics and ...

More documents

Recommendations

Info

1 Introduction Organizations face the problem of how to match individuals with the job in which they are most productive and to provide them with incentives. In practice one observes that job assignments are often used to motivate employees – leading to an inefficient allocation of employees to jobs. For example, people often are promoted to a job for which they are less competent and then remain there, a phenomenon known as the Peter Principle (Peter and Hull 1969). The appearance of such inefficiencies seems puzzling to economists. Why do firms not separate job assignment policies from the provision of incentives, leaving the latter to pay-for-performance schemes? The literature on careers in organizations stresses the role of incomplete information about employees’ abilities and contractual imperfections in accounting for inefficiencies in job assignments (see the section on related literature). Our approach is complementary to this. We start from a moral hazard model and show that job assignment decisions cannot be separated from incentive provision even if the principal is able to write a complete contract and knows about the agent’s productivity. The driving force behind inefficient job assignments in our model is a static trade-off between incentive provision and efficient allocation of agents to jobs. We develop this trade-off in a moral hazard model, where a risk neutral principal assigns a risk neutral and wealth constrained agent to one of two jobs (a high ability and a low ability one). The probability with which the agent succeeds in producing a high output depends in each job on his ability, and his effort. While the principal knows the ability of the agent, she cannot observe his effort and thus designs an output-contingent reward scheme to induce a certain effort. The cost of getting the agent to exert this effort level in a given job depends on how likely it is that success in this job was generated by high and not by low effort. Because the job in which an agent of a certain ability produces the highest expected output need not be the one in which it is cheapest for the principal to implement effort, a trade-off between efficient job assignment and incentive provision arises – leading to an inefficient assignment policy. 1 The necessary and sufficient condition that we derive for such an inefficient outcome to occur depends on the relative informativeness of output about effort in the two jobs, i.e., the ranking of likelihood ratios across jobs. The rather technical condition becomes more intuitive once we interpret the high ability job as a position higher up in the hierarchy than the low ability job. Jobs further down 1 One might suspect that the root of inefficiencies in job assignments are distortions in implemented effort levels that arise in moral hazard problems. Our binary effort model shows that this is not the case. It allows us to consider the job assignment problem for a parameter range where the principal does not distort effort and implements the efficient level in both jobs. Our continuous effort model combines the effects of assignments and distortions in implemented effort levels. 2
in the hierarchy often put low demands in terms of the inputs ability and effort. Hence, in the low ability job success might be quite likely even without hard work (i.e., it is is a relatively easy task). In the high ability job, if the agent does not work hard, there is a bigger drop in expected output (i.e., it is a more difficult task for him). Seeing such an agent succeed in what is for him a difficult job, thus, indicates that he must have worked hard. So the high ability job poses a harder test of the agent’s effort than the low ability job, and this makes it less costly to get the agent to exert effort. That output in the higher level job is often more informative about the agent’s effort than output in the lower level job is a view also found in the literature (Baker, Gibbons, and Murphy 1994, Maskin, Qian, and Xu 2000, Ortega 2003). As we show, the reduced cost of incentives (due to differences in informativeness about effort across hierarchy levels) outweighs the negative effect of a lower success probability near the ability cutoff level for efficient job assignment. Hence, the principal sets a lower ability threshold for assignment to the more informative higher hierarchy level than is efficient. The mechanism at work is a static one: the job assignment decision in one period affects the contemporaneous cost of providing incentives. This static mechanism on its own offers several new insights into the driving forces governing promotion decisions in firms. Embedding our model in a stylized dynamic framework and extending it to allow for continuous effort, we show that it may be optimal for a firm to promote an employee to a higher level job even though it knows that he will be less productive than he could be in his previously held position. This finding provides a new perspective on possible roots of the Peter Principle: even in ideal circumstances where a firm is perfectly aware of its employees’ abilities one may find employees in jobs for which they are not well suited. Our analysis highlights that promoting an employee to a job for which he is less competent need not lead to an observed decline in output – a narrow definition of the Peter Principle often used in the literature (e.g. Lazear 2004). Output may actually rise because the promoted agent works harder – hiding the fact that he actually is untalented for his new job. Existing theoretical treatments of promotions in firms have ignored this effect of job assignments on implemented effort levels: they either abstract from incentives altogether or assume that effort is constant across hierarchy levels. This effect may, however, be an important driving force for promotion decisions, as our analysis shows. We therefore suggest an extended definition of the Peter Principle that includes both the possibility that a promoted agent works harder or less hard than he would if he were reassigned to the previous job. Our setting with varying effort levels across hi- erarchical levels allows to show that an employee moving up the career ladder may earn more and produce more only because he has to work harder than he would in his old job. The paper is organized as follows. Next we discuss the related literature. Section 2 3
Page 1: Job Assignments under Moral Hazard
Page 5 and 6: promotion. 3 Bernhardt (1995) forma
Page 7 and 8: Figure 1: Illustration of the singl
Page 9 and 10: If this fails to hold the principal
Page 11 and 12: 2.4 Discussion: Biases in hierarchi
Page 13 and 14: 3.1.2 The continuous effort model O
Page 15 and 16: eSB h (θ) = 0.5 F B k eh (θ) +
Page 17 and 18: 3. In the lower ability range of jo
Page 19 and 20: Figure 5: Expected earnings and cos
Page 21 and 22: Applying our simple model to a prom
Page 23 and 24: Proposition 5 Suppose job h is loca
Page 25 and 26: fh(ē, ˜ θ)−Ch(ē, ˜ θ) = fl(
Page 27 and 28: if he were instead assigned to job
Page 29 and 30: Clark, D. J., and C. Riis (2001):
Page 31: Rosen, S. (1982): “Authority, Con

Job Assignments under Moral Hazard - School of Economics and ...

You also want an ePaper? Increase the reach of your titles

Delete template?

Save as template?