Performance evaluation inflation and compression

0361-3682/$ see front matter 2012 Elsevier Ltd http://dx.doi.org/10.1016/j.aos.2012.09.001 ⇑ Corresponding author. Tel.: +1 412 268 9861; fa E-mail address: [email protected] (R. G We provide a behavioral account of subjective performance evaluation inflation (i.e., leniency bias) and compression (i.e., centrality bias). When a manager observes noisy signals of employee performance and the manager strives to produce accurate ratings but feels worse about unfavorable errors than about favorable errors, the manager’s selfishly optimal ratings will be biased upwards. Both the uncertainty about performance and the asymmetry in the manager’s utility are necessary conditions for performance evaluation inflation. Moreover, the extent of the bias is increasing in the variance of the performance signal and in the asymmetry in aversion to unfair ratings. Uncertainty about performance also leads to compressed ratings. These results suggest that performance appraisals based on well-defined unambiguous criteria will have less bias. Additionally, we demonstrate that employer and employee can account for biased performance evaluations when they agree to a contract, and thus, to the extent leniency bias and centrality bias persist, these biases hurt employee performance and lower firm productivity. 2012 Elsevier Ltd. All rights reserved.