Promote Internally or Hire Externally? The Role of Trust, Reciprocity, and Performance Measurement Precision

Abstract

Managers often face the choice between promoting an internal employee and hiring an external candidate. Using an incentivized experiment, we examine managers’ promote/hire decision and employees’ behavior before and after that decision in a setting in which the external candidate has superior ability. Consistent with theory on trust and reciprocity, results indicate that employees invest in costly effort to increase their chances of promotion, and managers reciprocate this effort by promoting them despite their inferior ability. Managers tend to anchor their promote/hire decision on employees’ early effort level rather than their sharp increase in effort immediately prior to that decision. Importantly, we predict and find that managers are more likely to promote internally rather than hire externally under a less precise performance measurement system. Results also suggest that promoted (non-promoted) employees who exerted high effort react more positively (negatively) to their managers’ promote/hire decision under a more precise system.

Keywords: Promotion, Trust, Reciprocity, Performance Measurement

JEL Classification: M40, M51