The bonding cost in subjective performance evaluation

Abstract

This paper studies the optimal contract under conditions where the principal modifies the level of subjectivity in performance evaluation, thereby augmenting the existing literature that assumes subjective evaluations as fully unverifiable. The level of subjectivity represents the ease with which the principal can modify evaluations, and this choice impacts the costs of implementation and alteration. We show that in the optimal contract, the principal invariably engages in downward adjustments of evaluation and that the principal determines the level of subjectivity through a trade-off between providing incentives to the agent and making these downward revisions.