Human Capital And The Referral Heuristic

Human capital trades much more like real estate than equities. If you're on the market to buy a basket of S&P 500 stocks, millions can exchange accounts with one click. However, if you're looking to hire someone for a job or find a suitable partner to combine genetic material with, the last step of the evaluation process is always offline, in person, and high touch, much like a house inspection before you seal the deal.

In the job market, some predictive attributes can be translated into text - whether they went to college, what they studied, etc. But for several things we care about - integrity, confidence, ability to think on one's feet, and most importantly, red flags that are quite hard to put a finger on, a 15-minute in-person interaction can tell us things that resumes, cover letters, or a thousand other fields on a digital form can't. Much of our cognitive machinery has evolved precisely to observe and evaluate other human beings, and to spot deception.However, these in-person interactions or even phone calls are much less scalable. In any evaluation process, you can do a fixed number of them. The typical recruitment funnel is set up to maximize the expected value of these high-touch, personalized interactions.

The earliest stages of the funnel typically involve a low-touch process like screening resumes where recruiters look for signals that might correlate with success (being hired). But at this stage, the type of information that's available is very different. You get almost no information about things like trustworthiness but get data points on degrees, achievements, experience, etc. An ideal recruiter is basically trying to identify the most predictive fields out of those available to select people for the next stage of the process, even if these fields are not necessarily the primary determinants of success in the final stage.

The limitations of the hiring process: An example

Let's say XYZ is a think tank looking to hire a Research Analyst. XYZ is a small organization working on fiscal policy. They are looking for someone that combines quantitative skills with written communication skills. Some research experience is a must. Experience in fiscal policy is not a must. Since XYZ is lean, it's important that the new hire be able to work independently with little supervision and handle uncertainty and ambiguity.

For simplicity, assume they only have two stages to their evaluation process. The first is a resume and cover letter screen, and the second involves in-person interviews and a short research assignment. Given how time-consuming the second phase of the selection process is, XYZ has decided they can only invite 5 applicants to this stage.

The CEO of XYZ has laid out the following rubric for evaluating the new hire:

The recruiter from XYZ receives 1,000 resumes and cover letters. They decide they will screen all the resumes (spending <1 min per resume) to select 100 applicants for further screening. They will read cover letters for these 100 applicants before deciding which 10 applicants they invite to the second round interviews.

When the recruiter screens the resumes, the only metric they can reliably screen for is familiarity with fiscal policy - since this would manifest in prior work experience, internships, or coursework. The recruiter can also check if applicants have experience that might be indicative of the ability to handle quantitative work. One could perhaps make a weaker case for written communication skills, but with written communication, the question is one of quality, not whether someone can literally write. Moreover, almost everyone is likely to include something that claims they've written research reports. Even though relevance of work experience is far from the only metric that matters, it's the only one in this case that can be reliably screened for.

The disadvantage faced by unconventional applicants

Now imagine you were applying to this job. You have strong quantitative skills and have been writing on Substack - mostly data-heavy pieces on areas like immigration policy. You've gotten good feedback and grown your subscriber base by yourself. This already makes you a pretty good fit for the job. You've demonstrated that you can work independently and have validated your research and quantitative skills without any institutional support. You also have a math major, so working in a different quantitative domain is unlikely to be a problem for you. But if the recruiter were rating you (out of 10) on relevance of work experience, they might give you a 6 or 7, especially if a majority of their applicants have worked in other think tanks, for example.

Now, of course, if you could make the recruiter click on your Substack or even chat with you for 2 minutes, you would probably be invited to the second round. But the recruiter doesn't have time to validate this; they only have time to eyeball the relevant metric on which they can rank people into 0s and 1s. From the perspective of the recruiter, even if they're well-informed about what matters on the job, their immediate goal is to find a way to rank order the large pile they have in front of them, and on that metric, you're not very likely to make it through to the next round.

The role of institutional incentives in recruiter behavior

Institutional incentives probably matter too. Recruiters are probably not incentivized sufficiently to maximize the expected value of the hire. If they are in-house, they are probably paid a salary to do a job, in which case they will care first and foremost about not being perceived as incompetent. If this Substack writer guy turns out to be a great hire, the recruiter won't get applauded. But if he presents as a moron during the interviews, then the CEO might ask the recruiter why they brought someone who had little relevant work experience.

Sometimes firms hire external recruiters who are compensated in the form of commissions if the firm hires a candidate they bring in. In this case, recruiters do have an incentive to bring in people that get hired. But they are still going to try to sort by fields that are most legible in the early stages. They don't have the bandwidth to go find gems in the rough.

This presents a challenge for a few types of applicants - those who are looking to transition to a new area/industry, those who are a good fit because they have done something analogous in a different setting, and applicants who seem average on legible metrics but exceptional on soft skills. Basically, if you meet every item on the preferred qualifications list on a job application, you might be able to get away with applying on job portals, but otherwise, you're at a significant disadvantage. And so is the firm. But this is how the world works. Feedback loops are not very strong, and companies don't actually know if they end up with sub-optimal applicants long after they hire someone, and even then, they don't know the counterfactual of how much they would have accomplished with an even better candidate.

Bypassing the screening process: The value of referrals and networking

You should try to find a way to ease the company's constraints. The problem here is that the company can't find the time to carefully consider how some unconventional applicants might be great. But you could convince them if only they would interview you or look at some of your work. Well, find a way to help the company outsource this interview free of cost.

This is what referrals or warm introductions really are. It's taking someone else's word on a candidate's softer, richer attributes that are infeasible for them to know themselves beforehand. Since the screening process does very little to mitigate the risk of underperformance on attributes that can't be captured on resumes but are tested later on or on the job, any information on these attributes will be valued quite highly. If someone in the organization knows someone who has worked with you, they now have an applicant with much lower risk across a bunch of dimensions. Needless to say, the colder, more distant the recommendation, the more they'll discount this information. (By the way, companies that have large, structured employee referral programs might be an example of this. Some employees refer friends and acquaintances without much discernment, appearing magnanimous and buying lottery tickets on commissions. But internal recruiters probably learn to discount this appropriately over time.)

This brings us to one of the most dreaded verbs - Networking. Most people would rather apply for 50 jobs on LinkedIn than write one email to an acquaintance asking them for a chat. This lines up with our psychological constitution. Once you have a resume and cover letter ready, applying for the next job requires relatively little effort. Yet, checking that off your list gives you a significant psychological reward. Meanwhile, everything you can do to bypass that screening process is ridden with uncertainty and embarrassment.

Conclusion: Actionable advice for job seekers

The fact that psychological biases keep a significant number of people from networking adds to the value of pursuing this strategy. All else equal, the less common a strategy is, the more valuable it becomes for those who employ it effectively.

In summary, the hiring process, while designed to identify the best candidates, often falls short due to the limitations of the screening process and institutional incentives. Unconventional applicants, who might be a great fit for the job, are at a disadvantage because their strengths are not easily captured by the metrics used in the initial screening.

In the next post, I will dive deeper into practical networking advice - especially for those that worry a lot about coming across as a sleazy car salesman.