Discretion and bias in performance evaluation

Most of the economics literature on compensation and organizations builds from the theory of agency.’ For the most part, the literature analyzes situations in which agents’ performance can be controlled by tying compensation to objective performance measures such as output or sales. It ignores the fact that most compensation arrangements involve superiors’ subjectire. and hence non-contractible. judgements about employee performance. In our view, much of what is interesting about actual employment relations follows from the observation that ‘performance appraisal is a process by which humans judge other humans’ [Milkovich and Wigdor (1991)]. This paper studies the implications of subjective performance evaluation for compensation policies and for the efficiency of employment relations. Our objectives are two fold. First. we propose the importance of subjectivity of evaluations to better understand organizatlonal practices such as politicking, favoritism. and compression of wage scales. Second, we hope to orient the study of subjective performance evaluation in ways that are consistent with empirical evidence on what organizations actually do.