The Peter Principle: A Theory of Decline

40 Pages Posted: 25 May 2003

See all articles by Edward P. Lazear

Edward P. Lazear

Stanford Graduate School of Business; National Bureau of Economic Research (NBER); IZA Institute of Labor Economics

Multiple version iconThere are 2 versions of this paper

Date Written: April 2003

Abstract

Some have observed that individuals perform worse after being promoted. The Peter Principle, which states that people are promoted to their level of incompetence, suggests that something is fundamentally misaligned in the promotion process. This view is unnecessary and inconsistent with the data. Below, it is argued that ability appears lower after promotion purely as a statistical matter. Being promoted is evidence that a standard has been met. Regression to the mean implies that future ability will be lower, on average. Firms optimally account for the regression bias in making promotion decisions, but the effect is never eliminated. Rather than evidence of a mistake, the Peter Principle is a necessary consequence of any promotion rule. Furthermore, firms that take it into account appropriately adopt an optimal strategy. Usually, firms inflate the promotion criterion to offset the Peter Principle effect, and the more important is the transitory component relative to total variation in ability, the larger the amount that the standard is inflated. The same logic applies to other situations. For example, it explains why movie sequels are worse than the original film on which they are based and why second visits to restaurants are less rewarding than the first.

Keywords: Peter Principle, Regression to the Mean, Stochastic

JEL Classification: J00, J6

Suggested Citation

Lazear, Edward P., The Peter Principle: A Theory of Decline (April 2003). IZA Discussion Paper No. 759. Available at SSRN: https://ssrn.com/abstract=403880

Edward P. Lazear (Contact Author)

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National Bureau of Economic Research (NBER)

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IZA Institute of Labor Economics

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