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Tournaments and Liquidity Constraints for the Agents

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Author Info
Kosmas Marinakis () (Department of Economics, North Carolina State University)
Theofanis Tsoulouhas () (Department of Economics, North Carolina State University)

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Abstract

A celebrated result in the theory of tournaments is that relative performance evaluation (tournaments) is a superior compensation method to absolute performance evaluation (piece rate contracts) when the agents are risk-averse, the principal is risk-neutral or less risk-averse than the agents and production is subject to common shocks that are large relative to the idiosyncratic shocks. This is because tournaments get closer to the first best by filtering common uncertainty. This paper shows that, surprisingly, tournaments are superior even when agents are liquidity constrained so that transfers to them cannot fall short of a predetermined level. The rationale is that, by providing insurance against common shocks through a tournament, payments to the agents in unfavorable states increase and payments in favorable states decrease which enables the principal to satisfy tight liquidity constraints for the agents without paying any ex ante rents to them, while simultaneously providing higher-power incentives than under piece rates.

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Publisher Info
Paper provided by North Carolina State University, Department of Economics in its series Working Paper Series with number 019.

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Length: 20 pages
Date of creation: 2006
Date of revision: Apr 2008
Handle: RePEc:ncs:wpaper:019

Note: First draft 2006
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Related research
Keywords: piece rates; tournaments; liquidity constraints;

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Find related papers by JEL classification:
D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information
D21 - Microeconomics - - Production and Organizations - - - Firm Behavior

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References listed on IDEAS
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  1. Holmstrom, Bengt & Milgrom, Paul, 1987. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Econometrica, Econometric Society, vol. 55(2), pages 303-28, March. [Downloadable!] (restricted)
    Other versions:
  2. Edward P. Lazear & Sherwin Rosen, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Dominique M. Demougin & Devon A. Garvie, 1991. "Contractual Design with Correlated Information under Limited Liability," RAND Journal of Economics, The RAND Corporation, vol. 22(4), pages 477-489, Winter. [Downloadable!] (restricted)
    Other versions:
  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. [Downloadable!] (restricted)
  5. Barry J. Nalebuff & Joseph E. Stiglitz, 1983. "Prices and Incentives: Towards a General Theory of Compensation and Competition," Bell Journal of Economics, The RAND Corporation, vol. 14(1), pages 21-43, Spring. [Downloadable!] (restricted)
  6. Tsoulouhas, Theofanis, 1999. "Do tournaments solve the two-sided moral hazard problem?," Journal of Economic Behavior & Organization, Elsevier, vol. 40(3), pages 275-294, November. [Downloadable!] (restricted)
  7. Meyer, Margaret A & Vickers, John, 1997. "Performance Comparisons and Dynamic Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(3), pages 547-81, June.
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  8. Innes, Robert, 1993. "Debt, Futures and Options: Optimal Price-Linked Financial Contracts under Moral Hazard and Limited Liability," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(2), pages 271-95, May. [Downloadable!] (restricted)
  9. Theofanis Tsoulouhas & Kosmas Marinakis, 2007. "Tournaments with Ex Post Heterogeneous Agents," Working Paper Series 015, North Carolina State University, Department of Economics, revised Oct 2007. [Downloadable!]
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  10. Kosmas Marinakis & Theofanis Tsoulouhas, 2006. "Are Tournaments Optimal over Piece Rates under Limited Liability for the Principal?," Working Paper Series 009, North Carolina State University, Department of Economics, revised Sep 2006. [Downloadable!]
  11. Courty, Pascal & Marschke, Gerald, 2001. "Performance Incentives with Award Constraints," CEPR Discussion Papers 2720, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  12. Dominique Demougin & Claude Fluet, 2003. "Inequity Aversion in Tournaments," Cahiers de recherche 0322, CIRPEE. [Downloadable!]
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  13. Konrad, Kai A & Kovenock, Dan, 2006. "Multi-Stage Contests with Stochastic Ability," CEPR Discussion Papers 5844, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  14. Theofanis Tsoulouhas & Charles R. Knoeber & Anup Agrawal, . "Contests to Become CEO: Incentives, Selection and Handicaps," Working Paper Series 002, North Carolina State University, Department of Economics, revised Jul 2004. [Downloadable!]
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  15. 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. [Downloadable!] (restricted)
  16. Innes, Robert, 1993. "Financial Contracting under Risk Neutrality, Limited Liability and Ex ante Asymmetric Information," Economica, London School of Economics and Political Science, vol. 60(237), pages 27-40, February. [Downloadable!] (restricted)
  17. Green, Jerry R & Stokey, Nancy L, 1983. "A Comparison of Tournaments and Contracts," Journal of Political Economy, University of Chicago Press, vol. 91(3), pages 349-64, June. [Downloadable!] (restricted)
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  18. Juan-José Ganuza & Esther Hauk, 2006. "Allocating Ideas: Horizontal Competition in Tournaments," Journal of Economics & Management Strategy, Blackwell Publishing, vol. 15(3), pages 763-787, 09. [Downloadable!] (restricted)
    Other versions:
  19. Bhattacharya, Sudipto & Guasch, J Luis, 1988. "Heterogeneity, Tournaments, and Hierarchies," Journal of Political Economy, University of Chicago Press, vol. 96(4), pages 867-81, August. [Downloadable!] (restricted)
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