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Relative Performance Compensation, Contests, and Dynamic Incentives

  • Pablo Casas-Arce

    ()

    (Department of Economics and Business, Universitat Pompeu Fabra, and Barcelona Graduate School of Economics and IESE, 08005 Barcelona, Spain)

  • F. Asís Martínez-Jerez

    ()

    (Harvard Business School, Harvard University, Boston, Massachusetts 02163)

Registered author(s):

    Contests (or tournaments) are pervasive in organizations. They help performance evaluation by eliminating common shocks affecting agents' performance. However, tournaments are less effective when participants have heterogeneous ability because participants may conclude that the ability gap is too large to be overcome by their effort. Our theoretical analysis shows that a similar loss of motivation arises when tournaments take place over multiple periods because interim performance acts in a way that is similar to heterogeneous ability. Analyzing the sales contests organized by a commodities company, we document that winning participants decrease their effort as their lead extends, whereas the effort of trailing participants fades only when the gap to a winning position is very large. We also show that, on average, when contests are introduced they induce a higher level of effort among participants, although the incentives weaken as the number of participants increases. Finally, we demonstrate that although retailers respond to the multiple performance dimensions of the incentive program in part by shifting effort toward sales of more expensive products, they channel most of the increased effort toward reaching more customers.

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    File URL: http://dx.doi.org/10.1287/mnsc.1090.1021
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 55 (2009)
    Issue (Month): 8 (August)
    Pages: 1306-1320

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    Handle: RePEc:inm:ormnsc:v:55:y:2009:i:8:p:1306-1320
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    1. Bull, Clive & Schotter, Andrew & Weigelt, Keith, 1987. "Tournaments and Piece Rates: An Experimental Study," Journal of Political Economy, University of Chicago Press, vol. 95(1), pages 1-33, February.
    2. Ronald G. Ehrenberg & Michael L. Bognanno, 1988. "Do Tournaments Have Incentive Effects?," NBER Working Papers 2638, National Bureau of Economic Research, Inc.
    3. Alannah Orrison & Andrew Schotter & Keith Weigelt, 2004. "Multiperson Tournaments: An Experimental Examination," Management Science, INFORMS, vol. 50(2), pages 268-279, February.
    4. Moldovanu, Benny & Sela, Aner, 1999. "The Optimal Allocation of Prizes in Contests," Sonderforschungsbereich 504 Publications 99-75, Sonderforschungsbereich 504, Universität Mannheim;Sonderforschungsbereich 504, University of Mannheim.
    5. Anderson, T. W. & Hsiao, Cheng, 1982. "Formulation and estimation of dynamic models using panel data," Journal of Econometrics, Elsevier, vol. 18(1), pages 47-82, January.
    6. Bengt Holmstrom & Paul R. Milgrom, 1985. "Aggregation and Linearity in the Provision of Intertemporal Incentives," Cowles Foundation Discussion Papers 742, Cowles Foundation for Research in Economics, Yale University.
    7. Nickell, Stephen J, 1981. "Biases in Dynamic Models with Fixed Effects," Econometrica, Econometric Society, vol. 49(6), pages 1417-26, November.
    8. Brickley, James A. & Zimmerman, Jerold L., 2001. "Changing incentives in a multitask environment: evidence from a top-tier business school," Journal of Corporate Finance, Elsevier, vol. 7(4), pages 367-396, December.
    9. Edward P. Lazear & Sherwin Rosen, 1979. "Rank-Order Tournaments as Optimum Labor Contracts," NBER Working Papers 0401, National Bureau of Economic Research, Inc.
    10. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    11. Oriana Bandiera & Iwan Barankay & Imran Rasul, 2005. "Social Preferences and the Response to Incentives: Evidence from Personnel Data," The Quarterly Journal of Economics, Oxford University Press, vol. 120(3), pages 917-962.
    12. Rosen, Sherwin, 1986. "Prizes and Incentives in Elimination Tournaments," American Economic Review, American Economic Association, vol. 76(4), pages 701-15, September.
    13. Edward P. Lazear, 1996. "Performance Pay and Productivity," NBER Working Papers 5672, National Bureau of Economic Research, Inc.
    14. Knoeber, Charles R & Thurman, Walter N, 1994. "Testing the Theory of Tournaments: An Empirical Analysis of Broiler Production," Journal of Labor Economics, University of Chicago Press, vol. 12(2), pages 155-79, April.
    15. Main, Brian G M & O'Reilly, Charles A, III & Wade, James, 1993. "Top Executive Pay: Tournament or Teamwork?," Journal of Labor Economics, University of Chicago Press, vol. 11(4), pages 606-28, October.
    16. Al-Najjar, Nabil I., 2008. "Large games and the law of large numbers," Games and Economic Behavior, Elsevier, vol. 64(1), pages 1-34, September.
    17. O. Ashenfelter & D. Card (ed.), 1999. "Handbook of Labor Economics," Handbook of Labor Economics, Elsevier, edition 1, volume 3, number 3.
    18. Slade, Margaret E, 1996. "Multitask Agency and Contract Choice: An Empirical Exploration," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 37(2), pages 465-86, May.
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