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Promotion Tournaments and Individual Performance Pay

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  • Anja Schöttner
  • Veikko Thiele

Abstract

We analyze the optimal combination of promotion tournaments and individual performance pay in an employment relationship. An agent's effort is non-observable and he has private information about his suitability for promotion. We find that the principal does not provide individual incentives if it is sufficiently important to promote the most suitable candidate. Thus, we give a possible explanation for why individual performance schemes are less often observed in practice than predicted by theory. Furthermore, optimally trading off incentive and selection issues causes a form of the Peter Principle: The less suitable agent has an inefficiently high probability of promotion.

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Bibliographic Info

Paper provided by Sonderforschungsbereich 649, Humboldt University, Berlin, Germany in its series SFB 649 Discussion Papers with number SFB649DP2007-045.

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Length: 31 pages
Date of creation: Aug 2007
Date of revision:
Handle: RePEc:hum:wpaper:sfb649dp2007-045

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Keywords: Promotion Tournaments; Piece Rates; Hidden Characteristics; Hidden Action;

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  1. Holmstrom, Bengt & Milgrom, Paul, 1991. "Multitask Principal-Agent Analyses: Incentive Contracts, Asset Ownership, and Job Design," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 7(0), pages 24-52, Special I.
  2. Erling Barth & Bernt Bratsberg & Torbjørn Hægeland & Oddbjørn Raaum, 2008. "Who pays for performance?," International Journal of Manpower, Emerald Group Publishing, Emerald Group Publishing, vol. 29(1), pages 8-29, May.
  3. Joao Ricardo Faria, 2000. "An Economic Analysis of the Peter and Dilbert Principles," Working Paper Series, Finance Discipline Group, UTS Business School, University of Technology, Sydney 101, Finance Discipline Group, UTS Business School, University of Technology, Sydney.
  4. Dirk Sliwka, 2007. "Trust as a Signal of a Social Norm and the Hidden Costs of Incentive Schemes," American Economic Review, American Economic Association, vol. 97(3), pages 999-1012, June.
  5. Johannes Münster, 2007. "Selection Tournaments, Sabotage, and Participation," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 16(4), pages 943-970, December.
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  7. Sherwin Rosen, 1985. "Prizes and Incentives in Elimination Tournaments," NBER Working Papers 1668, National Bureau of Economic Research, Inc.
  8. Theofanis Tsoulouhas & Charles Knoeber & Anup Agrawal, 2007. "Contests to become CEO: incentives, selection and handicaps," Economic Theory, Springer, Springer, vol. 30(2), pages 195-221, February.
  9. Kong-Pin Chen, 2003. "Sabotage in Promotion Tournaments," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 19(1), pages 119-140, April.
  10. Tirole, Jean, 1986. "Hierarchies and Bureaucracies: On the Role of Collusion in Organizations," Journal of Law, Economics and Organization, Oxford University Press, Oxford University Press, vol. 2(2), pages 181-214, Fall.
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  12. Baker, George & Gibbs, Michael & Holmstrom, Bengt, 1994. "The Internal Economics of the Firm: Evidence from Personnel Data," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 109(4), pages 881-919, November.
  13. Florian Ederer, 2010. "Feedback and Motivation in Dynamic Tournaments," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 19(3), pages 733-769, 09.
  14. Bernhardt, Dan, 1995. "Strategic Promotion and Compensation," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 62(2), pages 315-39, April.
  15. Koch, Alexander K. & Nafziger, Julia, 2007. "Job Assignments under Moral Hazard: The Peter Principle Revisited," IZA Discussion Papers 2973, Institute for the Study of Labor (IZA).
  16. Eriksson, Tor, 1999. "Executive Compensation and Tournament Theory: Empirical Tests on Danish Data," Journal of Labor Economics, University of Chicago Press, University of Chicago Press, vol. 17(2), pages 262-80, April.
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Cited by:
  1. Benoît Mahy & François Rycx & Mélanie Volral, 2011. "Does Wage Dispersion Make All Firms Productive?," Working Papers CEB, ULB -- Universite Libre de Bruxelles 11-021, ULB -- Universite Libre de Bruxelles.
  2. Kräkel, Matthias & Schöttner, Anja, 2012. "Internal labor markets and worker rents," Journal of Economic Behavior & Organization, Elsevier, vol. 84(2), pages 491-509.

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