Does referral-based hiring exacerbate agency problems?
51 Pages Posted: 14 Apr 2020 Last revised: 15 Jul 2021
Date Written: July 12, 2020
We investigate circumstances in which referral-based hiring can exacerbate rather than mitigate agency problems. When incentive contracts cannot fully align employees’ incentives with the interests of the firm, employees may behave opportunistically. Referred job candidates likely obtain inside information from existing employees about opportunistic incentive responses and it is this information that exacerbates agency problems. Our research setting enables us to distinguish between referred and non-referred employees. It also features a context in which the incentive contract consists of two measures with different properties (efficiency and quality), which allow for opportunistic incentive responses, i.e., sacrificing quality for efficiency. We find that referred employees focus more on efficiency and less on quality than non-referred employees. We further document the persistence of this behavior and their differential departure likelihood. Our findings suggest that referral-based hiring can exacerbate agency problems when incentive contracts allow for opportunistic gains.
Keywords: employee selection, referrals, financial incentives, distorted effort allocation, multi-tasks
JEL Classification: M12, M41, M54
Suggested Citation: Suggested Citation