Optimal Promotion Policies with the Looking-Glass Effect

This article considers a model where the agent is uncertain about his innate ability and instead makes an inference from others' (namely, the principal's) perception, as often emphasized in the psychology literature. When the principal has superior knowledge about the agent's productivity than the agent himself, the principal has an incentive to use promotions strategically to boost the agent's self-confidence. Within this framework the optimal promotion policy depends not only on the agent's current expected ability type but also on the history of his previous job assignments. We use this fact to explain why we rarely observe demotions in organizations.