Performance, promotion, and the Peter Principle

This paper considers why organizations use promotions, rather than just mon etary bonuses, to motivate employees even though this may conflict with eff icient assignment of employees to jobs. When performance is unverifiable, u se of promotion reduces the incentive for managers to be affected by influe nce activities that would blunt the effectiveness of monetary bonuses. When employees are risk neutral, use of promotion for incentives need not disto rt assignments. When they are risk averse, it may-sufficient conditions for this are given. The distortion may be either to promote more employees tha n is efficient (the Peter Principle effect) or fewer.