University Competition, Grading Standards and Grade Inflation
Some universities have more students with high GPAs than others, and claim that it is because they have better students. We show how strategic considerations lead better universities to set lower standards for good grades. In our model, universities are distinguished by the distribution of student academic abilities. Job placement and wages hinge on a firm's assessment of a student's productivity given the student's university, grade and productivity signal. Universities choose grading standards to maximize the total wage bill of their graduates. We identify conditions under which better universities endogenously set lower grading standards, exploiting the fact that firms cannot distinguish between "good A's" and "bad A's". In sharp contrast, a social planner sets stricter grading standards at better universities. Finally, we show that an increase in skilled jobs drives grade inflation, and identify conditions under which grading standards fall faster at better schools.