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Subjective Performance Evaluation and Collusion

Thiele, Veikko (2007): Subjective Performance Evaluation and Collusion.

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In many employment relationships, employees' contributions to firm value are not contractible. Firms therefore need to use alternative mechanisms to provide their employees with incentives. This paper investigates and contrasts two alternatives for a firm to provide effort incentives: (i) to subjectively evaluate the employee's performance; and (ii), to delegate the performance evaluation to a supervisor as a neutral party. Supervision generates contractible information about the employee's performance, but could result in vertical collusion. This paper demonstrates that supervision can be optimal whenever firms cannot perfectly identify employees' contributions to firm value. This can be observed despite ensuring collusion-proofness is shown to impose additional cost on firms in form of too low-powered incentives and inefficiently high fixed payments to employees and supervisors. Thus, this paper provides a supplementary rationale for the dominance of multi-level organizational hierarchies in practise.

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