The best worker is not always the best candidate for manager. In these cases, do firms promote the best potential manager or the best worker in their current job? Using microdata on the performance of sales workers at 131 firms, we find evidence consistent with the Peter Principle, which proposes that firms prioritize current job performance in promotion decisions at the expense of other observable characteristics that better predict managerial performance. We estimate that the costs of promoting workers with lower managerial potential are high, suggesting either that firms are making inefficient promotion decisions or that the benefits of promotion-based incentives are great enough to justify the costs of managerial mismatch. We find that firms manage the costs of the Peter Principle by placing less weight on sales performance in promotion decisions when managerial roles entail greater responsibility and when frontline workers are incentivized by strong pay for performance.
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∗We thank Peter Cappelli, Lisa Kahn, Steve Kaplan, Maximilian Kasy, Eddie Lazear, Inessa Liskovich (discussant), Vladimir Mukharlyamov (discussant), Paige Ouimet (discussant), Michaela Pagel (discussant), Amanda Pallais, Brian Phelan, Thomas Peeters, Lamar Pierce, Felipe Severino (discussant), Kathryn Shaw (discussant), Mike Waldman, and seminar participants at CEPR Milan, CUHK, FOM Conference, GSU CEAR, Gerzensee ESSFM, Harvard Business School, HKUST, Hong Kong University, ITAM, Melbourne FIRCG, MIT Economics, MIT Sloan, the MEA Meetings, Nanjing University, NBER (Corporate Finance, Personnel Economics, and Organizational Economics), Purdue, SOLE, Tsinghua PBC, University of Chicago, University of Hong Kong, University of Miami, University of Minnesota Carlson, Wharton People Analytics Conference, Wharton People & Organizations Conference, and Yale Junior Finance Conference for helpful comments. We thank Menaka Hampole, Leland Bybee, and Gen Li for excellent research assistance. This research was funded in part by the Initiative on Global Markets and the Fama Miller Center at the Chicago Booth School of Business and the International Center for Finance at Yale SOM. Corresponding author: email@example.com.