Agency in Hierarchies: Middle Managers and Performance Evaluations - Forthcoming, Journal of the European Economic Association
This paper studies the optimal joint design of incentives and performance rating scales in a principal-manager-worker hierarchy. The principal wants to motivate the worker to exert unobservable effort at the minimum feasible cost. Given the worker's effort, two signals are realized: public and verifiable output and a private non-verifiable signal known only to the manager. The principal may try to elicit the manager's private information by requiring her to evaluate the worker's performance. Payments may depend on output and the manager's evaluation. I show that the principal can achieve no more than what is feasible with a binary rating scale. I also identify scenarios where subjective evaluations are valuable (non-valuable), reduced transparency is advantageous, and forced ranking outperforms individual evaluations.
Disentangling Moral Hazard and Adverse Selection - American Economic Review, Vol. 114, NO. 1, January 2024
(joint with Hector Chade and Jeroen Swinkels)
While many real-world principal-agent problems have both moral hazard and adverse selection, existing tools largely analyze only one at a time. Do the insights from the separate analyses survive when the frictions are combined? We develop a simple method decoupling to study both problems at once. When decoupling works, everything we know from the separate analyses carries over, but interesting interactions also arise. We provide simple tests for whether decoupling is valid. We develop and numerically implement an algorithm to calculate the decoupled solution and check its validity. We also provide primitives for decoupling to work, and analyze several extensions.
Limited Liability and Non-responsiveness in Agency Models- Games and Economic Behavior, Volume 128, July 2021
(joint with Humberto Moreira)
This paper analyzes the optimal menu of contracts offered by a risk-neutral principal to a risk-averse agent under moral hazard, adverse selection, and limited liability. We show that a limited liability constraint causes pooling of the most efficient agent types. We also find sufficient conditions under which full pooling is optimal, regardless of the agent’s risk aversion or type distribution. Our model suggests that offering a single contract is often optimal in environments with moral hazard, adverse selection, and in which the principal faces a limited liability constraint.
Monitoring, Performance Reviews, and Retaliation - R&R at Management Science
We analyze the effects of retaliation on optimal contracts in a hierarchy consisting of a principal, a monitor, and an agent. With probability $m$, the monitor observes a signal about the agent's effort and decides what to report to the principal. With probability $(1-m)$, the monitor only observes an uninformative default signal realization. The agent retaliates against the monitor and the principal whenever the monitor's report reduces the agent's payment from a default level. We show that the principal's optimal contracting problem can be divided into two steps: first, an information acquisition stage. The principal chooses how much retaliation to tolerate, and more retaliation generates more informative signals (in the Blackwell sense) about the agent's effort. Second, given the information acquired, the principal designs the optimal payment schemes, which pool moderately (potentially all) bad agent's performances with the uninformative signal realization. The empirical literature documents that supervisors are reluctant to provide poor ratings and that performance reports are often inflated and compressed. We show that such a pattern in performance appraisals can arise as firms' optimal responses to retaliation concerns.
The Effect of Exit Rights on Cost-based Procurement Contracts - Online Appendix
(joint with Rodrigo Andrade and Humberto Moreira)
This paper studies optimal procurement contracts in an environment with dynamic information arrival and ex-post exit rights. A procuring agency designs contracts for a firm that receives information over time. In the first period, the firm gets a private non-fully informative signal about the project's cost. In the second period, the firm fully learns the cost and decides whether to keep the contract or take an exogenous ex-post outside option. We show that if the ex-post outside option value is sufficiently close to the ex-ante, the optimal mechanism takes a static form: all first-period signal reports are pooled into a single contract, and payments depend solely on the second-period reports. The interpretation is that optimal contracts do not condition transfers on ex-ante self-reported cost estimates but only on realized verifiable costs. Finally, we study if competition among a large number of firms allows the procuring agency to screen the first-period information and implement the second-best allocation. We show that the answer depends on the value of the ex-post outside option: for low values, the procuring agency can screen the first-period information and implement the second-best allocation at approximately no additional cost, while for high values, the cost of implementing the second-best allocation diverges. We relate our findings to firms' incentives to under-report expected costs, and the ubiquitous cost-overruns observed empirically in public projects.
Non-monetary Interventions, Workforce Retention and Hospital Quality: Evidence from the English NHS
(joint with Giuseppe Moscelli, Melisa Sayli, Jo Blanden, and Marco Mello)
Excessive turnover can significantly impair an organization’s performance. Using high-quality administrative data and staggered difference-in-differences strategies, we evaluate the impact of a programme that encouraged public hospitals to increase staff retention by providing data and guidelines on how to improve the non-pecuniary aspects of nursing jobs. We find that the programme has decreased the nurse turnover rate by 4.49%, decreased exits from the public hospital sector by 5.38%, and reduced mortality within 30 days from hospital admission by 3.45%, preventing 11,400 deaths. Our results are consistent with a theoretical model in which information is provided to managers of multi-unit organizations, who trade off coordinating decisions across units and adapting them to local conditions.
Foreign Nurses and Hospital Quality: Evidence from Brexit
(joint with Giuseppe Moscelli, and Marco Mello)
Excessive turnover can significantly impair an organization’s performance. Using high-quality administrative data, we exploit the 2016 Brexit referendum as a migration shock to evaluate the impact of reduced labour supply on the provision of hospital care. After the referendum, a sharp drop in the number of early-career new joiners from Europe resulted in a considerable decrease in the share of EU nurses in the English NHS. Using an enclave instrumental variable empirical strategy, we find that emergency readmission rates increased, and more so in hospital organizations more exposed to the missing inflow of new joiners. A theoretical model shows that this is consistent with a decrease in the quality of new hires