Social Preferences and the Use of Noisy Performance Measures

This study investigates managers’ willingness to incur a cost to obtain information that allows them to evaluate and reward their employees more fairly. Using an experiment, we examine if managers use their discretion in subjective performance evaluation processes to ex post filter out uncontrollable noise from a performance measure and reward their employees’ real effort levels. In contrast to the standard self-interest model but consistent with models that incorporate reciprocity and social preferences our experimental results show that managers are prepared to incur a personal cost just to ensure that their subordinates receive a fair reward. Moreover, our findings indicate that superiors’ willingness to pay increases as the noisiness of the performance measure increases and as the expected effort of the subordinate is higher. The study contributes to the existing literature on subjective performance evaluation by investigating the effects of social preferences which are likely to play a role next to direct self interest (Prendergast and Topel 1993) and cognitive biases (e.g. Lipe and Salterio 2000)