Tournament incentives and reserve management

This paper examines the impact of internal tournament incentives on reserve management within the property‐liability insurance industry. We find a positive relationship between internal tournament incentives and reserve errors, suggesting that a larger tournament prize is associated with more conservative loss‐reserve management. In contrast to the literature on nonfinancial firms, we do not observe a positive association between tournament incentives and risk‐taking behavior or performance. The overall evidence indicates that vice presidents participating in internal tournaments prioritize strong financial health over performance. Moreover, the positive effect of tournament incentives on conservative reserve management is more pronounced for insurers with more volatile returns and a higher ratio of claim loss reserves to total liabilities. This effect attenuates for larger insurers, those underwriting long‐tail lines, and those operating in less competitive environments. Our findings also suggest that the Sarbanes–Oxley Act significantly influences executives' reserve behavior. Finally, we show that stronger board monitoring is associated with more conservative reserve practices in internal tournaments.