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Tournaments versus Piece Rates under Limited Liability

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  • Matthias Kräkel

Abstract

The existing literature on the comparison of tournaments and piece rates as alternative incentive schemes has focused on the case of unlimited liability. However, in practice real workers' wealth is typically restricted. Therefore, this paper compares both schemes under the assumption of limited liability. The results show that if the cost function is suffciently convex, first-best effort will be more likely implemented under piece rates than under tournaments. Moreover, if first-best implementation is not achieved and workers earn positive rents, efforts and profits will be larger for piece rates than for tournaments given suffciently convex costs. While tournaments offer a partial insurance due to their fixed prizes, piece rates may not work any longer if potential losses become prohibitively high. Finally, if risk is suffciently high, piece rates will dominate tournaments despite the partial insurance effect of tournament compensation. Since effort costs and risk may depend on an individual worker's characteristics, on the characteristics of his job and on his hierarchical position, these findings have important implications for the choice of incentive schemes and the allocation of workers in firms

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Bibliographic Info

Paper provided by University of Bonn, Germany in its series Bonn Econ Discussion Papers with number bgse8_2004.

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Length: 53
Date of creation: Jun 2004
Date of revision:
Handle: RePEc:bon:bonedp:bgse8_2004

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Keywords: incentives; limited liability; piece rates; rank-order tournaments;

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References

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  1. Edward P. Lazear & Sherwin Rosen, 1979. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc.
  2. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Internal Economics of the Firm: Evidence from Personnel Data," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 881-919, November.
  3. Richard B. Freeman & Morris M. Kleiner, 1998. "The Last American Shoe Manufacturers: Changing the Method of Pay to Survive Foreign Competition," NBER Working Papers 6750, National Bureau of Economic Research, Inc.
  4. Malcomson, James M, 1984. "Work Incentives, Hierarchy, and Internal Labor Markets," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 486-507, June.
  5. Malcomson, James M, 1986. "Rank-Order Contracts for a Principal with Many Agents," Review of Economic Studies, Wiley Blackwell, vol. 53(5), pages 807-17, October.
  6. Dominique Demougin & Claude Fluet, 2003. "Inequity Aversion in Tournament," CIRANO Working Papers 2003s-18, CIRANO.
  7. Bognanno, Michael L, 2001. "Corporate Tournaments," Journal of Labor Economics, University of Chicago Press, vol. 19(2), pages 290-315, April.
  8. Edward P. Lazear, 1996. "Performance Pay and Productivity," NBER Working Papers 5672, National Bureau of Economic Research, Inc.
  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. Jerry R. Green & Nancy L. Stokey, 1982. "A Comparison of Tournaments and Contracts," NBER Working Papers 0840, National Bureau of Economic Research, Inc.
  11. Pitchford, Rohan, 1998. "Moral hazard and limited liability: The real effects of contract bargaining," Economics Letters, Elsevier, vol. 61(2), pages 251-259, November.
  12. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Wage Policy of a Firm," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 921-55, November.
  13. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
  14. Knoeber, Charles R & Thurman, Walter N, 1994. "Testing the Theory of Tournaments: An Empirical Analysis of Broiler Production," Journal of Labor Economics, University of Chicago Press, vol. 12(2), pages 155-79, April.
  15. Bull, Clive & Schotter, Andrew & Weigelt, Keith, 1987. "Tournaments and Piece Rates: An Experimental Study," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 1-33, February.
  16. Ehrenberg, Ronald G & Bognanno, Michael L, 1990. "Do Tournaments Have Incentive Effects?," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1307-24, December.
  17. Son Ku Kim, 1997. "Limited Liability and Bonus Contracts," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 6(4), pages 899-913, December.
  18. Park, Eun-Soo, 1995. "Incentive Contracting under Limited Liability," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 4(3), pages 477-90, Fall.
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Cited by:
  1. Clark, Derek & Konrad, Kai A., 2006. "Contests with multi-tasking," Discussion Papers, Research Unit: Market Processes and Governance SP II 2006-14, Social Science Research Center Berlin (WZB).
  2. Gerald Eisenkopf, 2006. "Deterring gaming with imperfect evaluation methods," Working Papers of the Research Group Heterogenous Labor 06-04, Research Group Heterogeneous Labor, University of Konstanz/ZEW Mannheim.
  3. James W. Bono, 2008. "Sales contests, promotion decisions and heterogeneous risk," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 29(4), pages 371-382.

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