Optimal Grading

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Executive Summary

Assuming that teachers are concerned with human capital formation and students - with ability signaling, in this paper the authors model a teacher-student relationship as an agency problem with conflicting interests. In the model, the teacher elicits effort from the student rewarding for it with a grade, the utility of which to the student is an ability signal inferred by the job market. In the event that the job market does not observe individual teachers' grading practice, teachers find grades as costless rewards and optimally choose to be lenient in grading.

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