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Investment Tournaments: When Should a Rational Agent Put All Eggs in One Basket?

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  • Michael Schwarz
  • Sergei Severinov
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    Abstract

    We study "investment tournaments," a class of decisionproblems involving gradual allocation of investment among severalalternatives whose values are subject to shocks. The decision maker'spayoff is determined by the final values of the alternatives. An important example of such tournaments is the career choice problem, since a person typically starts by investing in learning several professions.We show that in many cases it is optimal for the decision maker to allocate all resources to the most promising alternative in each time period. We also show that in promotion tournaments the workers optimally exert higher efforts at an early stage in order to capture a larger share of employer's investment, such as mentoring. (c) 2010 by The University of Chicago. All rights reserved..

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    Bibliographic Info

    Article provided by University of Chicago Press in its journal Journal of Labor Economics.

    Volume (Year): 28 (2010)
    Issue (Month): 4 (October)
    Pages: 893-922

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    Handle: RePEc:ucp:jlabec:v:28:y:2010:i:4:p:893-922

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    Web page: http://www.journals.uchicago.edu/JOLE/

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    1. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-64, October.
    2. Weitzman, Martin L, 1979. "Optimal Search for the Best Alternative," Econometrica, Econometric Society, vol. 47(3), pages 641-54, May.
    3. Michael Schwarz & Konstantin Sonin, 2001. "The Variable Value Environment: Auctions and Actions," Working Papers w0020, Center for Economic and Financial Research (CEFIR), revised Oct 2005.
    4. Barut, Yasar & Kovenock, Dan, 1998. "The symmetric multiple prize all-pay auction with complete information," European Journal of Political Economy, Elsevier, vol. 14(4), pages 627-644, November.
    5. Fredrik Andersson, 2002. "Career Concerns, Contracts, and Effort Distortions," Journal of Labor Economics, University of Chicago Press, vol. 20(1), pages 42-58, January.
    6. Christopher Ferrall, 1996. "Promotions and Incentives in Partnerships: Evidence from Major U.S. Law Firms," Canadian Journal of Economics, Canadian Economics Association, vol. 29(4), pages 811-27, November.
    7. Holmstrom, Bengt, 1999. "Managerial Incentive Problems: A Dynamic Perspective," Review of Economic Studies, Wiley Blackwell, vol. 66(1), pages 169-82, January.
    8. Morgan, Peter & Manning, Richard, 1985. "Optimal Search," Econometrica, Econometric Society, vol. 53(4), pages 923-44, July.
    9. Bhattacharya, Sudipto & Guasch, J Luis, 1988. "Heterogeneity, Tournaments, and Hierarchies," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 867-81, August.
    10. Eriksson, Tor, 1999. "Executive Compensation and Tournament Theory: Empirical Tests on Danish Data," Journal of Labor Economics, University of Chicago Press, vol. 17(2), pages 262-80, April.
    11. Akerlof, George A, 1976. "The Economics of Caste and of the Rat Race and Other Woeful Tales," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 599-617, November.
    12. Taylor, Curtis R, 1995. "Digging for Golden Carrots: An Analysis of Research Tournaments," American Economic Review, American Economic Association, vol. 85(4), pages 872-90, September.
    13. Landers, Renee M & Rebitzer, James B & Taylor, Lowell J, 1996. "Rat Race Redux: Adverse Selection in the Determination of Work Hours in Law Firms," American Economic Review, American Economic Association, vol. 86(3), pages 329-48, June.
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