1. Managerial Economics and Organizational Architecture, 5e Chapter 16: Individual Performance Evaluation
McGraw-Hill/Irwin
Copyright © 2009 by The McGraw-Hill Companies, Inc. All Rights Reserved.

2. Performance Evaluation
Evaluations provide employees feedback on achievement and ways to improve
Evaluations are used to determine rewards and sanctions
Performance evaluation entail evaluating employees as well as subunit of the firm
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3. Incentive Compensation Again
Principal-agent model
Employee output: Q = e +   objective performance measure
Compensation: W = W0 + Q  compensating differential
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4. Implicit Assumptions Principal knows agent’s production function
Output is single quantitative measure of performance
Output can be observed at zero cost
Employee cannot game the measure
Employee produces a single output
Mutually beneficial contract is feasible
Employee works independently
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5. Setting Performance Benchmarks
Time and motion studies
Engineers estimate the amount of time a task requires
Determines most effective work method
Past performance and ratchet effect
Employees have incentives to only meet the goal and not exceed it
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6. Measurement Costs Accounting system may need to be developed
Information systems improved
Value-maximizing firm improves measures as long as incremental benefits justify costs
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7. Opportunism Gaming Horizon problem
Employees may engage in dysfunctional activities to improve their evaluations
Horizon problem
Short-run objective performance measure may cause employees to focus on results that influence their evaluation only over their remaining time with the firm
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8. Relative Performance Evaluation
Evaluate worker output relative to their co-workers in the same job
Within the firm
jobs not always identical
group has incentive to punish “rate busters”
incentive to hire less competent workers
Across firms
data hard to obtain
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9. Subjective Performance Evaluation
Firms often use subjective evaluation along with objective measures
Multiple tasks and unbalanced effort
Workers have incentives to concentrate on activities that are easily measured
The subjective measure will allow the supervisor to determine cooperation and other difficult to measure activities
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10. Subjective Evaluation Methods
Standard rating scales
Rank employees on various performance factors
Goal-based systems
Set annual goals and then measure whether the employee achieved them
Frequency
Often more frequent reviews are too costly
May be beneficial with new hires
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11. Problems with Subjective Evaluations
Supervisor shirking
Forced distribution
May result in good employees being evaluated poorly
Influence costs
Reneging
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12. Combining Performance Measures
Few job performance measures are purely objective or subjective
Both types can be inaccurate
increasing inaccuracy of either places greater weight on other
inaccuracies increase employee risk
Both can induce dysfunctional behaviors
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13. Team Performance Team production Team evaluation
Individual output: Qi = 5e + 
Team output: Qt = 4e2 + 
Team value added: E(Qt) > 2E(Qi) when e>2.5
Team evaluation
peer evaluations to alleviate free-rider problems
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14. Comparing Individual and Team OutputQ
Conrad and Dina’s team output
Sum of Conrad’s and Dina’s individual outputs
Expected output 25 e
2.5
Conrad’s and Dina’s individual effort levels
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15. Government Regulation of Labor Markets
Anti-discrimination regulations dictate clear performance evaluation systems
May be inconsistent with value maximization
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