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Contests to become CEO: incentives, selection and handicaps

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  • Theofanis Tsoulouhas

    ()

  • Charles Knoeber

    ()

  • Anup Agrawal

    ()

Abstract

Should a firm favor insiders (handicap outsiders) when selecting a CEO? One reason to do so is to take advantage of the contest to become CEO as a device for providing current incentives to employees. An important reason not to do so is that this can reduce the ability of future CEOs and, hence, future profits. The trade-off between providing current incentives and selecting the most able individual to become CEO is the focus of this paper. If insiders are good enough (better or nearly as good as outsiders), it is typically optimal to handicap outsiders, sometimes so severely that they have no chance to win the contest. However, if outsiders are sufficiently better than insiders, selection dominates and it is the insiders who are severely handicapped. Our model provides useful insight into contests to become CEO and rationalizes empirical regularities in the source of CEOs chosen by firms.

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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 30 (2007)
Issue (Month): 2 (February)
Pages: 195-221

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Handle: RePEc:spr:joecth:v:30:y:2007:i:2:p:195-221

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Web page: http://link.springer.de/link/service/journals/00199/index.htm

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Related research

Keywords: Contests; CEO contracts; Moral hazard;

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References

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  1. Joao Ricardo Faria, 2000. "An Economic Analysis of the Peter and Dilbert Principles," Working Paper Series, Finance Discipline Group, UTS Business School, University of Technology, Sydney 101, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  2. Sherwin Rosen, 1985. "Prizes and Incentives in Elimination Tournaments," NBER Working Papers 1668, National Bureau of Economic Research, Inc.
  3. Chan, William, 1996. "External Recruitment versus Internal Promotion," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 14(4), pages 555-70, October.
  4. Rajesh K. Aggarwal & Andrew A. Samwick, 1999. "Performance Incentives Within Firms: The Effect of Managerial Responsibility," NBER Working Papers 7334, National Bureau of Economic Research, Inc.
  5. Edward P. Lazear, 2004. "The Peter Principle: A Theory of Decline," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 112(S1), pages S141-S163, February.
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Cited by:
  1. Marinakis, Kosmas & Tsoulouhas, Theofanis, 2013. "Are tournaments optimal over piece rates under limited liability for the principal?," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 31(3), pages 223-237.
  2. DeVaro, Jed, 2011. "Using "opposing responses" and relative performance to distinguish empirically among alternative models of promotions," MPRA Paper 35175, University Library of Munich, Germany.
  3. Martijn Cremers & Yaniv Grinstein, 2009. "The Market for CEO Talent: Implications for CEO Compensation," Yale School of Management Working Papers, Yale School of Management amz2385, Yale School of Management, revised 01 Sep 2009.
  4. Anja Schöttner & Veikko Thiele, 2010. "Promotion Tournaments and Individual Performance Pay," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 19(3), pages 699-731, 09.
  5. Alasdair Brown & Subhasish M. Chowdhury, 2014. "The Hidden Perils of Affirmative Action: Sabotage in Handicap Contests," University of East Anglia Applied and Financial Economics Working Paper Series, School of Economics, University of East Anglia, Norwich, UK. 062, School of Economics, University of East Anglia, Norwich, UK..
  6. Theofanis Tsoulouhas & Kosmas Marinakis, 2007. "Tournaments with Ex Post Heterogeneous Agents," Working Paper Series, North Carolina State University, Department of Economics 015, North Carolina State University, Department of Economics, revised Oct 2007.
  7. Hao Jia & Stergios Skaperdas & Samarth Vaidya, 2012. "Contest Functions: Theoretical Foundations and Issues in Estimation," Working Papers 111214, University of California-Irvine, Department of Economics.
  8. Kräkel, Matthias & Schöttner, Anja, 2012. "Internal labor markets and worker rents," Journal of Economic Behavior & Organization, Elsevier, vol. 84(2), pages 491-509.
  9. repec:ebl:ecbull:v:4:y:2007:i:41:p:1-9 is not listed on IDEAS
  10. Rudi Stracke & Wolfgang Höchtl & Rudolf Kerschbamer & Uwe Sunde, 2014. "Incentives and selection in promotion contests: Is it possible to kill two birds with one stone?," Working Papers 2014-09, Faculty of Economics and Statistics, University of Innsbruck.
  11. Kosmas Marinakis & Theofanis Tsoulouhas, 2012. "A comparison of cardinal tournaments and piece rate contracts with liquidity constrained agents," Journal of Economics, Springer, vol. 105(2), pages 161-190, March.
  12. Riis, Christian, 2008. "Efficient Contests," MPRA Paper 10906, University Library of Munich, Germany.
  13. Waldman, Michael, 2013. "Classic promotion tournaments versus market-based tournaments," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 31(3), pages 198-210.
  14. Oliver Gürtler, 2010. "Collusion in homogeneous and heterogeneous tournaments," Journal of Economics, Springer, vol. 100(3), pages 265-280, July.
  15. Hammond, Robert G. & Zheng, Xiaoyong, 2013. "Heterogeneity in tournaments with incomplete information: An experimental analysis," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 31(3), pages 248-260.

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