Evaluation frequency in employment relations

Abstract

This thesis deals with the frequency of evaluations in employment relationships using microeconomic theory. In particular, it analyzes the behavior of a principal with bounded memory who can offer a two-period performance-based contract to one or several agents. After a review of relevant literature, this work contains three detailed models.

In the first model, both parties are risk-neutral and the principal can choose whether to evaluate the agent after each period or only at the end of the second period. If the agent is wealth-constrained, the option to evaluate him twice can be profitable. But without the constraint on the part of the agent, the principal will always prefer to evaluate only once in order to reduce evaluation costs. We also consider a modification of the profit function that can be interpreted as depreciation. Again, this leads to a trade-off between more and less frequent evaluations.

The second model builds on the first, introducing risk aversion of the agent as additional element. We show that risk aversion on behalf of the agent creates a decision problem concerning the risk-neutral principal's choice on the evaluation frequency. The optimal evaluation frequency will be determined by trading off the efficiency loss induced by the principal's bounded memory against the cost of an additional evaluation. We extend this setup to heterogeneously forgetful principals who compete for an agent. Competition has no impact on the optimal evaluation frequency, but as the agent is risk-averse, the less forgetful principal has a comparative advantage and can make a positive profit when a contract with one evaluation is implemented.

The third model investigates whether a differentiation in the frequency of employee evaluations can enhance an employer's ability to offer profitable screening contracts to heterogeneously productive agents. As performance data cannot be perfectly memorized over time, incentives crucially depend on the frequency with which this data is made explicit. The memory-bounded principal offers two-period performance-based contracts to a population of agents who are privately informed about their type. Compared to a situation with symmetric information, optimal screening contracts may include different evaluation frequencies for different types under asymmetric information.