How to hire smarter than the market: a toy model

https://erikbern.com/2020/01/13/how-to-hire-smarter-than-the-market-a-toy-model.html

We’re going to hire some people, so we look at a bunch of resumes and try to decide who’s going to make it to the next stage. The best candidates are the ones that are great at both A and B, and we’ll obviously bring them in. But some candidates are going to be good at A but not B, or vice versa. So you might choose to evaluate candidates on some combination of the two.

We can already see something interesting here, which is that the candidates we bring in exhibit a negative correlation between thing A and B, despite those being independent. This is something that’s called Berkson’s paradox.

An interesting paper claims a negative correlation between sales performance and management performance for sales people promoted into managers. The conclusion is that “firms prioritize current job performance in promotion decisions at the expense of other observable characteristics that better predict managerial performance”. While this paper isn’t about hiring, it’s the exact same theory here: the x-axis would be something like “expected future management ability” and the y-axis “sales performance”.

Because you’re hiring in a market with many other players, the really good candidates may simply have so many options that they are going to go to whatever company they want to and make a zillion dollars. Let’s say A and B are equally valued by you, as well as the market. Look at the green segment here: now there’s an even stronger negative correlation between A and B.

We actually see that the candidates we’re interested in went to a less than average fancy school. More generally, the conclusion when you’re hiring in a competitive market is that even if you think some quality is desirable, if you think the market overvalues that quality, you should look at the other side of the spectrum. This goes back to my example about buying a home.

What my model implies, is that there’s an “arbitrage opportunity” here. In fact, it’s a bit of a silver lining to the fact that the market is biased. Are companies systematically putting a premium on something? Then bet against them! Go after the underdogs. If every hiring manager acts in their own rational self-interest (which unfortunately, they don’t) then over time these biases will vanish and the market will converge towards efficiency.