Information Revelation in Relational Contracts

We explore subjective performance reviews in long-term employment relationships. We show that firms benefit from separating the task of evaluating the worker from the task of paying him. The separation allows the reviewer to better manage the review process, and can therefore reward the worker for his good performance with not only a good review contemporaneously, but also a promise of better review in the future. Such reviews spread the reward for the worker’s good performance across time and lower the firm’s maximal temptation to renege on the reward. The manner in which information is managed exhibits patterns consistent with a number of well-documented behavioral biases in performance reviews.

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