Grades as Noisy Signals

Abstract

Letter grades are noisy and coarse measures of academic achievement. However, these grades serve as important signals to both employers and to the student on his or her ability. I study the consequences of these noisy measures using administrative data from the National University of Singapore which records both the letter grades as well as the precise marks (0-100) received for each course that a given student takes. I exploit a regression discontinuity design -- specifically, close to the letter grade cutoffs, individuals with very similar achievement will receive different letter grades. I find that receiving a better grade in a single class for students on the margin results in 32 US dollars greater monthly earnings post-graduation. Looking at each letter grade cut off, I find that the effect is largest at the A- cutoff, followed by the A and B+ cutoffs. There is a null effect for elective courses, which indicates that only signals for major-relevant courses are important. The effect is driven by courses taken in years 1 and 2 (years 3 and 4 are graduation years). The effects are significantly larger for men than women, and for STEM courses than non-STEM courses. There are two possible mechanisms: 1) Employers use grades as a signal of ability and thus pay similar students different salaries based on this coarse measure. 2) Students interpret better or worse grades as a signal of their own ability which effects their future behavior and outcomes. Testing the second mechanism, I find that receiving a worse grade for students on the margin results in only slightly lower grades in future semesters, but these students take significantly "easier courses". This indicates that students under invest in human capital accumulation as a result of receiving a noisy negative signal of ability.