published in: Journal of Political Economy, 2004, 112 (S1), S141-S163
Some have observed that individuals perform worse after being promoted. The Peter
Principle, which states that people are promoted to their level of incompetence, suggests that
something is fundamentally misaligned in the promotion process. This view is unnecessary
and inconsistent with the data. Below, it is argued that ability appears lower after promotion
purely as a statistical matter. Being promoted is evidence that a standard has been met.
Regression to the mean implies that future ability will be lower, on average. Firms optimally
account for the regression bias in making promotion decisions, but the effect is never
eliminated. Rather than evidence of a mistake, the Peter Principle is a necessary
consequence of any promotion rule. Furthermore, firms that take it into account appropriately
adopt an optimal strategy. Usually, firms inflate the promotion criterion to offset the Peter
Principle effect, and the more important is the transitory component relative to total variation
in ability, the larger the amount that the standard is inflated. The same logic applies to other
situations. For example, it explains why movie sequels are worse than the original film on
which they are based and why second visits to restaurants are less rewarding than the first.
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