Supporting and Assessing Agents

• DOI: http://doi.org/10.1111/1475-679X.12173
• Date: 01 September 2017
• Published date: 01 September 2017
• Author: VOLKER LAUX

DOI: 10.1111/1475-679X.12173

Journal of Accounting Research

Vol. 55 No. 4 September 2017

Printed in U.S.A.

Supporting and Assessing Agents

VOLKER LAUX

∗

Received 6 June 2016; accepted 14 March 2017

ABSTRACT

This manuscript proposes a theory of why and when organizations “support”

their employees with resources, time, and freedom beyond what seems eco-

nomically optimal. The idea is that support plays an information-generating

role in that it renders output more informative about employees’ abilities.

This effect reduces the need to gather additional information about ability

via costly monitoring and commits the firm to make replacement/promotion

decisions that are more sensitive to performance. Consequently, support in-

directly strengthens employees’ career concern incentives and reduces the

pressure on costly bonus payments. I apply the model to tech companies,

academia, and capital budgeting.

JEL codes: D21; D81; D83; D86; M14; M41; M51

Keywords: ability assessment; career concerns; incentive contracting; re-

source allocation; termination/promotion

“If you give people freedom, they will amaze you.”

—Laszlo Bock, Google’s senior vice president of people operations.

1. Introduction

A key responsibility of superiors in organizations is to support their em-

ployees. Depending on the context, support can come in different forms

∗University of Texas at Austin, McCombs School of Business.

Accepted by Haresh Sapra. I thank an anonymous reviewer,Romana Autrey, Judson Caskey,

Paul Fischer, Pingyang Gao, Prasart Jongjaroenkamol, Christian Laux, Paul Newman, Korok

Ray, Phillip Stocken, and seminar participants at the University of Pennsylvania (Wharton),

Purdue University, University of Vienna, and the 2015 AAA Annual Meeting for valuable com-

ments and suggestions.

995

Copyright C, University of Chicago on behalf of the Accounting Research Center,2017

996 V.LAUX

such as resources, time, and freedom, but with the common goal of helping

employees to succeed in their positions. As an example, consider Google’s

so called “20% time” policy, which allows its engineers to spend 20% of

their work time to tinker and experiment on new projects of their choos-

ing. Many other tech companies such as 3M, Facebook, and LinkedIn have

similar programs. As another example, consider research universities that

shield their assistant professors from time-consuming service assignments

and high teaching loads, allowing them to focus on what is most impor-

tant for their careers—research. By helping employees excel at their jobs,

these types of support foster the goals of the organization, such as boosting

innovation and increasing research output.

In this paper, I argue that support plays an additional, more subtle role:

it helps management to assess employees’ abilities. Using the above quote

from Google’s human resources chief Laszlo Bock, the broad idea is that

“if you give people freedom, they will amaze you”—but only if they are

talented. Specifically, support gives high-ability employees who have clever

ideas more room to separate themselves from low-ability employees. This

feature of support not only renders output more useful for guiding the or-

ganization’s decisions of whom to retain, promote, or replace, but also re-

duces the need to obtain additional information about employees’ abilities

via costly monitoring. Loose monitoring in turn increases the probability

that output will be the decisive factor for replacement/promotion deci-

sions and thus strengthens employees’ implicit effort incentives. To better

exploit these effects, organizations will optimally offer a level of support

that exceeds the amount a naive application of the net present value rule

would dictate.

I consider a setting in which a principal hires an agent, who is either of

high or low ability and no one, including the agent, initially knows his abil-

ity. One of the principal’s key responsibilities is to support the agent in his

new position. Support is costly to the principal but helps the agent to be

successful in his job (generate a high output). A second key responsibility

of the principal is to assess the agent’s ability and fit and to decide whether

to retain him or hire someone else at an intermediate date. The princi-

pal cannot commit to a specific replacement policy upfront and replaces

the agent whenever this is ex post optimal.1Retaining top employees and

replacing disappointing ones is critical for the long-term success of most

organizations, including universities.2

The model shows that the principal’s two tasks of supporting and as-

sessing agents are inextricably intertwined. To learn about the agent’s

ability the principal can draw inferences from observed output but the

1See Aghion and Jackson [2016] for a paper that studies optimal replacement strategies

when the principal can commit to a replacement policy in advance.

2In a recent article about Amazon’s harsh firing practices, a former employee explains that

Amazon is “moving through a lot of people to identify and retain superstars.” See “Inside

Amazon: Wrestling Big Ideas in a Bruising Workplace,” TheNew York Times, August 15, 2015.