Subjective performance evaluation of employees with biased beliefs
Title: Subjective performance evaluation of employees with biased beliefs
Series/Number: EUI ECO; 2017/08
This paper analyses how worker optimism (and pessimism) affects subjective performance evaluation (SPE) contracts. We let an optimistic (pessimistic) worker overestimate (underestimate) the probability of observing an acceptable performance. The firm is better informed about performance than the worker and knows the worker's bias. We show that optimism (and pessimism): i) changes the optimal incentive scheme under SPE, ii) lowers the deadweight loss associated with SPE contracts, iii) can lead to a Pareto improvement by simultaneously lowering the firm's expected wage cost and raising the worker's expected compensation. In addition, we show that worker pessimism can lead to SPE contracts without a deadweight loss, in contrast to the standard case in the literature.
Subject: Optimism; Overconfidence; Contract; Moral hazard; Biased beliefs; D82; D84; D86; J41; J7
Type of Access: openAccess