Pitfall of Precision in Noisy Signaling

TL;DR

The paper reveals a paradox where increasing the precision of signals in screening processes can paradoxically decrease accuracy and welfare due to strategic signaling, with implications for discrimination and commitment.

Contribution

It uncovers the 'pitfall of precision' phenomenon, showing how higher signal precision can reduce screening effectiveness and welfare, and explores mitigation via commitment power.

Findings

Higher precision incentivizes strategic signaling from low-quality agents.

Increased precision can lower overall screening accuracy and welfare.

The phenomenon affects perceptions of statistical discrimination.

Abstract

A principal decides whether to approve an agent based on a noisy signal (e.g., test scores) generated by the agent. High-quality agents can produce high signals on average at lower cost, but the realizations are subject to noise that depends on the screening technology's precision. We uncover a paradoxical "pitfall of precision": when precision is already high, further improvements reduce screening accuracy and lower the principal's welfare. This occurs because greater precision incentivizes strategic signaling from more low-quality agents, outweighing the direct benefit from improved precision. The pitfall of precision also has implications for statistical discrimination: groups with noisier technologies face lower approval rates yet may be favored ex ante -- a reversal of discrimination. We also examine how commitment power helps mitigate the pitfall.