Getting What You Pay For

Michael Dorff (Southwestern) has just posted on SSRN his article The Rational Choice Myth: The Selection and Compensation of Critical Performers.  Here's the abstract:

Some positions within an organization wield unusual impact over the entity's success. The decision makers who hire these critical performers face a daunting task: to distinguish among closely comparable finalists in a context where small differences in talent can produce enormous outcome divergences. I apply research from psychology and behavioral law and economics to argue that decision makers demonstrate unwarranted confidence in their ability to distinguish among nearly identical candidates. The illusion of validity, representativeness bias, insensitivity to predictability, and the fundamental attribution error all impede decision makers' ability to make these fine distinctions. Once they have made a selection, cognitive dissonance induces inappropriate confidence in the outcome's validity and promotes excessive compensation. Involving a group in the decision may worsen these effects by imbuing outcomes with the false veneer of market legitimacy through social cascades and by discouraging contrary views through excessive consensus or groupthink.

I examine two types of critical performers with these insights: professional baseball players (where individual contributions to the enterprise can be measured directly) and public company CEOs (where they cannot). I conclude that in both contexts, these phenomena produce inefficient selection and compensation outcomes. While the relative absence of externalities argues against mandatory regulation in baseball, I propose changes in private ordering that should improve efficiency. In the corporate context, I argue that regulation is called for and propose a combination of mandatory compensation caps linked to firm size and a reverse auction among CEO finalists to determine the successful candidate.

I really enjoyed this article, and couldn't help thinking about how it might apply to hiring in the legal academy.  For example, Dorff states:

Once [a Board of Directors has chosen the new CEO], the directors have a ... strong emotional incentive to bolster their confidence that the decision was correct.  In order to reduce the psychological discomfort stemming from uncertainty in the face of a critical decision, the directors are likely to exaggerate the distinctions between the winning and losing candidates.  They are unlikely to bear in mind the difficulties involved in predicting future performance based on the available data.  Instead, they will remain insensitive to the predictability of the new CEO’s future performance and assert that they have made the clearly correct decision.

This sounds to me remarkably like the way we traditionally hire entry-level law faculty.  Our predictors of future success, such as the prestige of law school attended, are an empirically poor predictor of future performance, so we convince ourselves that we have found a star, then are loath to recognize, even years down the road, evidence indicating otherwise.  Dorff suggests:

Boards should choose a small group of finalists based on traditional criteria, all of whom they deem acceptable. They should then negotiate compensation with each member of the group, making clear that they will choose the candidate who proves most reasonable.  If boards cannot manage the production side of the equation, they should at least minimize cost.  In choosing from a CEO from among equivalently credentialed candidates, boards are effectively buying a lottery ticket.  Since each ticket has the same chance of winning, the highest expected value comes from bargaining down the price of the ticket, not from trying to predict which number will be drawn.

So, to continue the analogy to entry-level law teachers, the faculty should recommend to the dean a slate of candidates, and then let the dean do some bargaining.

Dorff's focus is on money, which makes sense given that he's writing about CEO and baseball salaries.  But in the market for entry-level law teachers, there may be more important things that a school could bargain for, such as institutional service and a commitment to innovative teaching.

rb