Loss averse agents and lenient supervisors in performance appraisal

A consistent empirical literature shows that in many organizations supervisors systemati- cally overrate their employees’ performance. Such leniency bias is at odds with the standard principal-agent model and has been explained with causes that range from social interac- tions to fairness concerns and to collusive behavior between the supervisor and the agent. We show that the principal-agent model, extended to consider loss-aversion and reference- dependent preferences, predicts that the leniency bias is comparatively less detrimental to effort provision than the severity bias. We test this prediction with a laboratory experi- ment where we demonstrate that failing to reward deserving agents is significantly more detrimental than rewarding undeserving agents. This offers a novel explanation as to why supervisors tend to be lenient in their appraisals.