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Rank-Order Tournaments as Optimum Labor Contracts

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  • Edward P. Lazear
  • Sherwin Rosen

Abstract

This paper analyzes compensation schemes which pay according to an individual's ordinal rank in an organization rather than his output level. When workers are risk neutral, it is shown that wages based upon rank induce the same efficient allocation of resources as an incentive reward scheme based on individual output levels. Under some circumstances, risk-averse workers actually prefer to be paid on the basis of rank. In addition, if workers are heterogeneous inability, low-quality workers attempt to contaminate high-quality firms, resulting in adverse selection. However, if ability is known in advance, a competitive handicapping structure exists which allows all workers to compete efficiently in the same organization.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 0401.

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Date of creation: Nov 1979
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Publication status: published as Lazear, Edward P. and Rosen, Sherwin. "Rank-Order Tournaments as Optimum Labor Contracts." Journal of Political Economy, Vol. 89, No. 5, (October 1981), pp. 841-864.
Handle: RePEc:nbr:nberwo:0401

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  1. Akerlof, George A, 1976. "The Economics of Caste and of the Rat Race and Other Woeful Tales," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 599-617, November.
  2. Riley, John G., 1975. "Competitive signalling," Journal of Economic Theory, Elsevier, vol. 10(2), pages 174-186, April.
  3. Milton Friedman, 1953. "Choice, Chance, and the Personal Distribution of Income," Journal of Political Economy, University of Chicago Press, vol. 61, pages 277.
  4. Alchian, Armen A & Demsetz, Harold, 1972. "Production , Information Costs, and Economic Organization," American Economic Review, American Economic Association, vol. 62(5), pages 777-95, December.
  5. Wilson, Charles, 1977. "A model of insurance markets with incomplete information," Journal of Economic Theory, Elsevier, vol. 16(2), pages 167-207, December.
  6. James A. Mirrlees, 1976. "The Optimal Structure of Incentives and Authority Within an Organization," Bell Journal of Economics, The RAND Corporation, vol. 7(1), pages 105-131, Spring.
  7. Rothschild, Michael & Stiglitz, Joseph E, 1976. "Equilibrium in Competitive Insurance Markets: An Essay on the Economics of Imperfect Information," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 630-49, November.
  8. Joesph E. Stiglitz, 1975. "Incentives, Risk, and Information: Notes Towards a Theory of Hierarchy," Bell Journal of Economics, The RAND Corporation, vol. 6(2), pages 552-579, Autumn.
  9. Gary S. Becker & George J. Stigler, 1974. "Law Enforcement, Malfeasance, and Compensation of Enforcers," The Journal of Legal Studies, University of Chicago Press, vol. 3(1), pages 1-18, January.
  10. Lazear, Edward P, 1979. "Why Is There Mandatory Retirement?," Journal of Political Economy, University of Chicago Press, vol. 87(6), pages 1261-84, December.
  11. Spence, A Michael, 1973. "Job Market Signaling," The Quarterly Journal of Economics, MIT Press, vol. 87(3), pages 355-74, August.
  12. Ross, Stephen A, 1973. "The Economic Theory of Agency: The Principal's Problem," American Economic Review, American Economic Association, vol. 63(2), pages 134-39, May.
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