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Tournament Rewards and Risk Taking

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Author Info
Hans K. Hvide (Norwegian School of Economics and Business)

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Abstract

I consider two seemingly unrelated puzzles; 1.Why is relative performance evaluation (RPE) used less in CEO compensation than agency theory suggests? 2.Why is sometimes, e.g., for fund managers, a mediocre performance more highly rewarded than excellence? I consider a simple tournament model, where agents can influence the spread of output in addition to its mean. I show that standard tournament rewards induce risky and lazy behavior from the agents. This finding sheds light on Puzzle 1. Second, I consider a scheme that ranks agents according to their relative closeness to a benchmar k. I show that there exists intermediate values of k such that the risky-lazy problem of the standard tournament can be mitigated. This result sheds light on Puzzle 2.

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Paper provided by Econometric Society in its series Econometric Society World Congress 2000 Contributed Papers with number 0163.

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Date of creation: 01 Aug 2000
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Handle: RePEc:ecm:wc2000:0163

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  1. Richard L. Fullerton & R. Preston McAfee, 1999. "Auctioning Entry into Tournaments," Journal of Political Economy, University of Chicago Press, vol. 107(3), pages 573-605, June. [Downloadable!] (restricted)
  2. Rajesh Aggarwal & Andrew A. Samwick, 1998. "The Other Side of the Tradeoff: The Impact of Risk on Executive Compensation," NBER Working Papers 6634, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  3. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
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  4. Dekel, Eddie & Ely, Jeffrey & Yilankaya, Okan, 2004. "Evolution of Preferences," Micro Theory Working Papers dekel-04-08-13-01-21-07, Microeconomics.ca Website, revised 09 Jun 2006. [Downloadable!]
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  5. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January. [Downloadable!] (restricted)
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  6. Brown, Keith C & Harlow, W V & Starks, Laura T, 1996. " Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 51(1), pages 85-110, March. [Downloadable!] (restricted)
  7. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn. [Downloadable!] (restricted)
  8. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier. [Downloadable!] (restricted)
  9. Heinkel, Robert & Stoughton, Neal M, 1994. "The Dynamics of Portfolio Management Contracts," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 7(2), pages 351-87. [Downloadable!] (restricted)
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