Referral-Based Hiring under Misaligned Financial Incentives

40 Pages Posted: 14 Apr 2020

See all articles by Chung-Yu Hung

Chung-Yu Hung

University of Melbourne, Department of Accounting

Anne M. Lillis

University of Melbourne

Anne Wu

National Chengchi University (Taipei)

Date Written: March 18, 2020


We investigate whether referral-based hiring exacerbates or mitigates control problems. Incentive contracts can be used to attract employees with certain traits. However, whether the outcomes are positive for the firm or not depends on the quality of incentive contracts. Our research setting enables us to distinguish between referred and non-referred employees. It also features an incentive contract that rewards two performance dimensions, production efficiency and quality. First, we document that compensation is more sensitive to production efficiency than to production quality. We also show that distorted efficiency-quality tradeoffs (i.e., achieving production efficiency at the expense of production quality) occur under this incentive design. We find that these tradeoffs are exacerbated for referred employees compared with non-referred employees. Our evidence suggests that when incentive contracts do not fully align the interests of employees and the firm, referral-based hiring can exacerbate rather than mitigate the misalignment.

Keywords: employee selection, referrals, financial incentives, distorted effort allocation, multi-tasks

JEL Classification: M12, M41, M54

Suggested Citation

Hung, Chung-Yu and Lillis, Anne and Wu, Anne, Referral-Based Hiring under Misaligned Financial Incentives (March 18, 2020). Available at SSRN: or

Chung-Yu Hung (Contact Author)

University of Melbourne, Department of Accounting ( email )

198 Berkeley Street
Melbourne, Victoria 3053

Anne Lillis

University of Melbourne ( email )

Parkville, Victoria 3010

Anne Wu

National Chengchi University (Taipei) ( email )

No. 64, Chih-Nan Road
Section 2
Wenshan, Taipei 11623

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