Tournament Rewards and Risk Taking
AbstractI 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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Date of creation: 01 Aug 2000
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- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- C50 - Mathematical and Quantitative Methods - - Econometric Modeling - - - General
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