Promotion Decisions and the Adoption of Explicit Potential Assessment

In this study, we leverage the transformation of a performance management system that shifts from only providing a performance rating to also providing an explicit assessment of potential. Although performance measures enable organizations to evaluate an employee’s past performance, they provide limited information regarding the employee’s potential to perform in a prospective job that requires a different skill set. Consequently, firms are gradually moving toward the incorporation of explicit potential assessments in their annual appraisal process to evaluate the employee’s promotability to a different task environment. Our data access allows us to provide evidence on the consequences of implementing a performance management system that adopted the explicit assessment of potential. We find that, on average, the performance of promoted employees is lower after implementation, suggesting that the potential assessment system is less effective in identifying candidates suitable for promotion. Additional analyses lead us to conclude that the difficulty of evaluating employee potential reduces performance upon promotion because of inaccurate recommendations of supervisors who do not sufficiently differentiate in their ratings. We thus identify variation in supervisors’ evaluation quality as an important source of the Peter Principle. This paper was accepted by Ranjani Krishnan, accounting. Supplemental Material: The online appendices and data files are available at https://doi.org/10.1287/mnsc.2022.02199 .