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Teams and Tournaments in Relational Contracts

  • Kvaløy, Ola

    ()

    (UiS Business School, University of Stavanger)

  • Olsen, Trond E.

    ()

    (Dept. of Business and Management Science, Norwegian School of Economics)

This paper analyses and compares optimal relational contracts between a principal/firm and a set of agents when (a) only aggregate output can be observed, and (b) individual outputs can be observed. We show that the optimal contract under (a) is a team incentive scheme where each agent is paid a maximal bonus for aggregate output above a threshold and a minimal (no) bonus otherwise. The team’s efficiency decreases with its size (number of agents) when outputs are non-negatively correlated, but may increase considerably with size if outputs are negatively correlated. In the case where individual output can be observed, we show that the optimal contract is a tournament scheme where the conditions for an agent to obtain the (single) bonus are stricter for negatively compared to positively correlated outputs. We finally show that if agents have bargaining power, firms may deliberately choose to organize production as a team where only aggregate output is observable. The team alternative is more likely to be superior under negatively correlated outputs.

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Paper provided by Department of Business and Management Science, Norwegian School of Economics in its series Discussion Papers with number 2013/13.

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Length: 55 pages
Date of creation: 30 Dec 2013
Date of revision:
Handle: RePEc:hhs:nhhfms:2013_013
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  17. Itoh Hideshi, 1993. "Coalitions, Incentives, and Risk Sharing," Journal of Economic Theory, Elsevier, vol. 60(2), pages 410-427, August.
  18. Lazear, Edward P & Rosen, Sherwin, 1981. "Rank-Order Tournaments as Optimum Labor Contracts," Journal of Political Economy, University of Chicago Press, vol. 89(5), pages 841-64, October.
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  24. Luis Rayo, 2007. "Relational Incentives and Moral Hazard in Teams," Review of Economic Studies, Oxford University Press, vol. 74(3), pages 937-963.
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