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When Randomization in Collective Tournaments is Profitable for the Principal

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  • Stefanie Aniela Lehmann

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Abstract

In the context of principal-agent theory risk is largely seen as a source that causes inefficiencies and lowers incentives and accordingly is not in the principal’s interest. In this paper I compare two different designs of a collective tournament where output in a team is generated through a particular two-stage production process. I show within a theoretical tournament framework that risk in terms of chance is beneficial from the point of view of a profit maximizing principal who organizes the tournament. Selecting an agent randomly that has to work at the final stage after all agents exerted effort at the first stage helps the principal to overcome a trade-off in incentive provision he faces when selecting the agent who works at the final stage before the tournament starts. This trade-off causes optimal efforts to be lower in a tournament without random selection compared to a tournament with random selection. As the higher efforts overcompensate additional wage costs the principal earns higher expected profits when selecting the agent that has to work at the second stage randomly after the first stage.

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Bibliographic Info

Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse19_2008.

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Length: 32
Date of creation: Dec 2008
Date of revision: Mar 2009
Handle: RePEc:bon:bonedp:bgse19_2008

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Postal: Bonn Graduate School of Economics, University of Bonn, Adenauerallee 24 - 26, 53113 Bonn, Germany
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Keywords: collective tournament; incentives; randomization; risk;

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  1. Moldovanu, Benny & Sela, Aner, 2002. "Contest Architecture," Sonderforschungsbereich 504 Publications 02-06, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim.
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  5. 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.
  6. Canice Prendergast, 2000. "The Tenuous Tradeoff Between Risk and Incentives," NBER Working Papers 7815, National Bureau of Economic Research, Inc.
  7. Dominique Demougin & Claude Fluet, 2003. "Inequity Aversion in Tournaments," Cahiers de recherche 0322, CIRPEE.
  8. Dragon, Robert & Garvey, Gerald T. & Turnbull, Geoffrey K., 1996. "A collective tournament," Economics Letters, Elsevier, vol. 50(2), pages 223-227, February.
  9. 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.
  10. Edward P. Lazear & Paul Oyer, 2007. "Personnel Economics," NBER Working Papers 13480, National Bureau of Economic Research, Inc.
  11. Lee, Sanghack, 1995. " Endogenous Sharing Rules in Collective-Group Rent-Seeking," Public Choice, Springer, vol. 85(1-2), pages 31-44, October.
  12. Ohlendorf, Susanne & Schmitz, Patrick W., 2008. "Repeated Moral Hazard, Limited Liability, and Renegotiation," CEPR Discussion Papers 6725, C.E.P.R. Discussion Papers.
  13. Clark, Derek J & Riis, Christian, 1998. "Competition over More Than One Prize," American Economic Review, American Economic Association, vol. 88(1), pages 276-89, March.
  14. Katz, Eliakim & Tokatlidu, Julia, 1996. "Group competition for rents," European Journal of Political Economy, Elsevier, vol. 12(4), pages 599-607, December.
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