Job Assignments Under Moral Hazard : The Peter Principle Revisited

Inefficient job assignments are usually explained with incomplete information about employees' abilities or contractual imperfections. We show that inefficient assignments arise even with full information about employees' types and complete contracts. Our further results provide a new perspective on the Peter Principle: The output of an employee who is not well suited for the job need not decline post promotion, because he is pushed to exert more effort. While promotions are desirable for most employees, they make the least able in a hierarchy level worse off: for them, earnings increase only because they work harder to compensate for their "incompetence."