Prehire Screening and Subjective Performance Evaluations

We study a two-stage model in which the agent’s ability is initially unknown to any party, but the principal can choose a prehire screening scheme to discover the agent’s ability before offering a contract. Perfect screening enables the principal to fine-tune the contract to the agent’s ability, but it also prevents her from enforcing a contract that is contingent on subjective interim performance measures. Given that interim performance measures are critical for motivating first-stage effort, the principal may benefit from adopting no screening or partial screening. When partial screening is employed, the halo effect—a commonly observed bias in subjective evaluation practices—emerges in the equilibrium.

This paper was accepted by Shivaram Rajgopal, accounting.